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Lanzhou Zhuangyuan Pasture Co Ltd (HKG:1533) is a small-cap stock with a market capitalization of HK$2.5b. 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. Here are a few basic checks that are good enough to have a broad overview of the company’s financial strength. However, since I only look at basic financial figures, I suggest you dig deeper yourself into 1533 here.
Does 1533 produce enough cash relative to debt?
1533 has built up its total debt levels in the last twelve months, from CN¥432m to CN¥498m , which comprises of short- and long-term debt. With this rise in debt, 1533 currently has CN¥740m remaining in cash and short-term investments , ready to deploy into the business. Moreover, 1533 has generated cash from operations of CN¥115m during the same period of time, leading to an operating cash to total debt ratio of 23%, indicating that 1533’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 1533’s case, it is able to generate 0.23x cash from its debt capital.
Does 1533’s liquid assets cover its short-term commitments?
Looking at 1533’s most recent CN¥679m liabilities, it appears that the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 1.24x. Usually, for Food companies, this is a suitable ratio since there’s a sufficient cash cushion without leaving too much capital idle or in low-earning investments.
Is 1533’s debt level acceptable?
With debt reaching 44% of equity, 1533 may be thought of as relatively highly levered. This is not uncommon for a small-cap company given that debt tends to be lower-cost and at times, more accessible. We can check to see whether 1533 is able to meet its debt obligations by looking at the net interest coverage ratio. A company generating earnings before interest and tax (EBIT) at least three times its net interest payments is considered financially sound. In 1533’s, case, the ratio of 3.75x suggests that interest is appropriately covered, which means that lenders may be less hesitant to lend out more funding as 1533’s high interest coverage is seen as responsible and safe practice.