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Lee and Man Paper Manufacturing Limited (HKG:2314) is a small-cap stock with a market capitalization of HK$30b. While investors primarily focus on the growth potential and competitive landscape of the small-cap companies, they end up ignoring a key aspect, which could be the biggest threat to its existence: its financial health. Why is it important? Assessing first and foremost the financial health is essential, since poor capital management may bring about bankruptcies, which occur at a higher rate for small-caps. The following basic checks can help you get a picture of the company's balance sheet strength. Nevertheless, potential investors would need to take a closer look, and I recommend you dig deeper yourself into 2314 here.
Does 2314 Produce Much Cash Relative To Its Debt?
Over the past year, 2314 has reduced its debt from HK$15b to HK$14b – this includes long-term debt. With this debt payback, the current cash and short-term investment levels stands at HK$2.0b to keep the business going. On top of this, 2314 has generated cash from operations of HK$6.1b in the last twelve months, leading to an operating cash to total debt ratio of 44%, meaning that 2314’s debt is appropriately covered by operating cash.
Can 2314 meet its short-term obligations with the cash in hand?
With current liabilities at HK$10b, it seems that the business has been able to meet these obligations given the level of current assets of HK$13b, with a current ratio of 1.3x. The current ratio is the number you get when you divide current assets by current liabilities. For Forestry companies, this ratio is within a sensible range since there is a bit of a cash buffer without leaving too much capital in a low-return environment.
Is 2314’s debt level acceptable?
With debt reaching 60% of equity, 2314 may be thought of as relatively highly levered. This is a bit unusual for a small-cap stock, since they generally have a harder time borrowing than large more established companies. No matter how high the company’s debt, if it can easily cover the interest payments, it’s considered to be efficient with its use of excess leverage. A company generating earnings before interest and tax (EBIT) at least three times its net interest payments is considered financially sound. In 2314's case, the ratio of 17.86x suggests that interest is comfortably covered, which means that lenders may be inclined to lend more money to the company, as it is seen as safe in terms of payback.
Next Steps:
Although 2314’s debt level is towards the higher end of the spectrum, its cash flow coverage seems adequate to meet obligations which means its debt is being efficiently utilised. Since there is also no concerns around 2314's liquidity needs, this may be its optimal capital structure for the time being. I admit this is a fairly basic analysis for 2314's financial health. Other important fundamentals need to be considered alongside. I suggest you continue to research Lee and Man Paper Manufacturing to get a more holistic view of the small-cap by looking at: