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Investors are always looking for growth in small-cap stocks like Johnson Electric Holdings Limited (HKG:179), with a market cap of HK$15.6b. However, an important fact which most ignore is: how financially healthy is the business? Assessing first and foremost the financial health is vital, since poor capital management may bring about bankruptcies, which occur at a higher rate for small-caps. Here are few basic financial health checks you should consider before taking the plunge. Nevertheless, this commentary is still very high-level, so I recommend you dig deeper yourself into 179 here.
How does 179’s operating cash flow stack up against its debt?
Over the past year, 179 has ramped up its debt from US$386m to US$512m , which is made up of current and long term debt. With this rise in debt, the current cash and short-term investment levels stands at US$209m , ready to deploy into the business. Moreover, 179 has produced cash from operations of US$401m in the last twelve months, resulting in an operating cash to total debt ratio of 78%, indicating that 179’s operating cash is sufficient to cover its debt. This ratio can also be interpreted as a measure of efficiency as an alternative to return on assets. In 179’s case, it is able to generate 0.78x cash from its debt capital.
Can 179 meet its short-term obligations with the cash in hand?
With current liabilities at US$917m, the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 1.52x. For Electrical companies, this ratio is within a sensible range as there’s enough of a cash buffer without holding too much capital in low return investments.
Does 179 face the risk of succumbing to its debt-load?
With a debt-to-equity ratio of 22%, 179’s debt level may be seen as prudent. This range is considered safe as 179 is not taking on too much debt obligation, which may be constraining for future growth. We can test if 179’s debt levels are sustainable by measuring interest payments against earnings of a company. Ideally, earnings before interest and tax (EBIT) should cover net interest by at least three times. For 179, the ratio of 25.46x 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.
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179 has demonstrated its ability to generate sufficient levels of cash flow, while its debt hovers at an appropriate level. Furthermore, the company exhibits an ability to meet its near term obligations should an adverse event occur. Keep in mind I haven’t considered other factors such as how 179 has been performing in the past. You should continue to research Johnson Electric Holdings to get a more holistic view of the stock by looking at: