Ozner Water International Holding Limited (HKG:2014) 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? Companies operating in the Consumer Durables industry facing headwinds from current disruption, even ones that are profitable, are inclined towards being higher risk. Evaluating financial health as part of your investment thesis is crucial. Here are few basic financial health checks you should consider before taking the plunge. Nevertheless, since I only look at basic financial figures, I suggest you dig deeper yourself into 2014 here.
How does 2014’s operating cash flow stack up against its debt?
2014 has built up its total debt levels in the last twelve months, from CN¥1.0b to CN¥1.9b , which comprises of short- and long-term debt. With this rise in debt, 2014’s cash and short-term investments stands at CN¥644m for investing into the business. Additionally, 2014 has generated CN¥274m in operating cash flow during the same period of time, leading to an operating cash to total debt ratio of 15%, signalling that 2014’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 2014’s case, it is able to generate 0.15x cash from its debt capital.
Can 2014 pay its short-term liabilities?
With current liabilities at CN¥1.9b, it seems that the business has been able to meet these obligations given the level of current assets of CN¥2.4b, with a current ratio of 1.23x. Generally, for Consumer Durables companies, this is a reasonable ratio as there’s enough of a cash buffer without holding too much capital in low return investments.
Is 2014’s debt level acceptable?
With a debt-to-equity ratio of 58%, 2014 can be considered as an above-average leveraged company. This is not uncommon for a small-cap company given that debt tends to be lower-cost and at times, more accessible. 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 2014’s case, the ratio of 3.01x suggests that interest is appropriately covered, which means that debtors may be willing to loan the company more money, giving 2014 ample headroom to grow its debt facilities.