Investors are always looking for growth in small-cap stocks like Kwality Limited (NSEI:KWALITY), with a market cap of ₹14.36B. However, an important fact which most ignore is: how financially healthy is the business? So, understanding the company’s financial health becomes vital, since poor capital management may bring about bankruptcies, which occur at a higher rate for small-caps. Here are a few basic checks that are good enough to have a broad overview of the company’s financial strength. Though, given that I have not delve into the company-specifics, I recommend you dig deeper yourself into KWALITY here.
How does KWALITY’s operating cash flow stack up against its debt?
KWALITY has built up its total debt levels in the last twelve months, from ₹15.20B to ₹16.62B , which comprises of short- and long-term debt. With this growth in debt, the current cash and short-term investment levels stands at ₹1.13B for investing into the business. Additionally, KWALITY has generated ₹1.93B in operating cash flow over the same time period, resulting in an operating cash to total debt ratio of 11.60%, indicating that KWALITY’s debt is not appropriately covered by operating cash. This ratio can also be a sign of operational efficiency as an alternative to return on assets. In KWALITY’s case, it is able to generate 0.12x cash from its debt capital.
Can KWALITY pay its short-term liabilities?
With current liabilities at ₹13.95B, it seems that the business has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 1.65x. Usually, for Food companies, this is a suitable ratio since there is a bit of a cash buffer without leaving too much capital in a low-return environment.
Is KWALITY’s debt level acceptable?
Since total debt levels have outpaced equities, KWALITY is a highly leveraged company. This is not uncommon for a small-cap company given that debt tends to be lower-cost and at times, more accessible. We can test if KWALITY’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 KWALITY, the ratio of 2.44x suggests that interest is not strongly covered, which means that lenders may be more reluctant to lend out more funding as KWALITY’s low interest coverage already puts the company at higher risk of default.
Next Steps:
KWALITY’s debt and cash flow levels indicate room for improvement. Its cash flow coverage of less than a quarter of debt means that operating efficiency could be an issue. However, the company exhibits an ability to meet its near term obligations should an adverse event occur. This is only a rough assessment of financial health, and I’m sure KWALITY has company-specific issues impacting its capital structure decisions. You should continue to research Kwality to get a more holistic view of the stock by looking at: