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Stocks with market capitalization between $2B and $10B, such as China Traditional Chinese Medicine Holdings Co Limited (HKG:570) with a size of HK$24.0b, do not attract as much attention from the investing community as do the small-caps and large-caps. However, generally ignored mid-caps have historically delivered better risk-adjusted returns than the two other categories of stocks. Today we will look at 570’s financial liquidity and debt levels, which are strong indicators for whether the company can weather economic downturns or fund strategic acquisitions for future growth. Remember this is a very top-level look that focuses exclusively on financial health, so I recommend a deeper analysis into 570 here.
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How does 570’s operating cash flow stack up against its debt?
Over the past year, 570 has reduced its debt from CN¥5.5b to CN¥5.2b , which is made up of current and long term debt. With this debt payback, the current cash and short-term investment levels stands at CN¥5.0b for investing into the business. Moreover, 570 has produced CN¥1.0b in operating cash flow over the same time period, leading to an operating cash to total debt ratio of 20%, signalling that 570’s current level of operating cash is not high enough to cover debt. This ratio can also be interpreted as a measure of efficiency as an alternative to return on assets. In 570’s case, it is able to generate 0.2x cash from its debt capital.
Can 570 pay its short-term liabilities?
With current liabilities at CN¥5.2b, it appears that the company has been able to meet these obligations given the level of current assets of CN¥13.8b, with a current ratio of 2.65x. For Pharmaceuticals companies, this ratio is within a sensible range since there’s a sufficient cash cushion without leaving too much capital idle or in low-earning investments.
Is 570’s debt level acceptable?
With debt at 31% of equity, 570 may be thought of as appropriately levered. This range is considered safe as 570 is not taking on too much debt obligation, which may be constraining for future growth. We can test if 570’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 570, the ratio of 8.98x suggests that interest is appropriately covered, which means that lenders may be less hesitant to lend out more funding as 570’s high interest coverage is seen as responsible and safe practice.