In This Article:
Shandong Xinhua Pharmaceutical Company Limited (HKG:719) is a small-cap stock with a market capitalization of HK$3.8b. 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? Pharmaceuticals companies, even ones that are profitable, are more likely to be higher risk. Assessing first and foremost the financial health is essential. Here are few basic financial health checks you should consider before taking the plunge. However, since I only look at basic financial figures, I’d encourage you to dig deeper yourself into 719 here.
How much cash does 719 generate through its operations?
Over the past year, 719 has reduced its debt from CN¥1.6b to CN¥1.3b , which is made up of current and long term debt. With this debt repayment, the current cash and short-term investment levels stands at CN¥905m for investing into the business. On top of this, 719 has generated cash from operations of CN¥517m over the same time period, resulting in an operating cash to total debt ratio of 39%, indicating that 719’s current level of operating cash is high enough to cover debt. This ratio can also be a sign of operational efficiency as an alternative to return on assets. In 719’s case, it is able to generate 0.39x cash from its debt capital.
Can 719 pay its short-term liabilities?
Looking at 719’s most recent CN¥2.1b liabilities, it appears that the company has been able to meet these commitments with a current assets level of CN¥2.3b, leading to a 1.09x current account ratio. For Pharmaceuticals 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.
Does 719 face the risk of succumbing to its debt-load?
719 is a relatively highly levered company with a debt-to-equity of 49%. This is not unusual for small-caps as debt tends to be a cheaper and faster source of funding for some 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 after interest and tax at least three times its net interest payments is considered financially sound. In 719’s case, the ratio of 6.48x suggests that interest is appropriately 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.