In This Article:
Evergreen Products Group Limited (HKG:1962) is a small-cap stock with a market capitalization of HK$1.4b. 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? Evaluating financial health as part of your investment thesis is crucial, since poor capital management may bring about bankruptcies, which occur at a higher rate for small-caps. We'll look at some basic checks that can form a snapshot the company’s financial strength. However, this is not a comprehensive overview, so I recommend you dig deeper yourself into 1962 here.
1962’s Debt (And Cash Flows)
1962 has built up its total debt levels in the last twelve months, from HK$514m to HK$686m , which is mainly comprised of near term debt. With this rise in debt, 1962's cash and short-term investments stands at HK$69m , ready to be used for running the business. Additionally, 1962 has produced cash from operations of HK$84m over the same time period, resulting in an operating cash to total debt ratio of 12%, indicating that 1962’s current level of operating cash is not high enough to cover debt.
Can 1962 pay its short-term liabilities?
With current liabilities at HK$759m, the company has been able to meet these commitments with a current assets level of HK$856m, leading to a 1.13x current account ratio. The current ratio is the number you get when you divide current assets by current liabilities. Generally, for Personal Products companies, this is a reasonable ratio since there is a bit of a cash buffer without leaving too much capital in a low-return environment.
Is 1962’s debt level acceptable?
With a debt-to-equity ratio of 97%, 1962 can be considered as an above-average leveraged company. This is somewhat unusual for small-caps companies, since lenders are often hesitant to provide attractive interest rates to less-established businesses. 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 1962's case, the ratio of 7.66x suggests that interest is appropriately covered, which means that lenders may be willing to lend out more funding as 1962’s high interest coverage is seen as responsible and safe practice.
Next Steps:
1962’s high cash coverage means that, although its debt levels are high, the company is able to utilise its borrowings efficiently in order to generate cash flow. Since there is also no concerns around 1962's liquidity needs, this may be its optimal capital structure for the time being. Keep in mind I haven't considered other factors such as how 1962 has been performing in the past. You should continue to research Evergreen Products Group to get a more holistic view of the small-cap by looking at: