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Small-caps and large-caps are wildly popular among investors, however, mid-cap stocks, such as Sembcorp Industries Ltd (SGX:U96), with a market capitalization of S$4.6b, rarely draw their attention from the investing community. Despite this, commonly overlooked mid-caps have historically produced better risk-adjusted returns than their small and large-cap counterparts. Today we will look at U96’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. Note that this information is centred entirely on financial health and is a top-level understanding, so I encourage you to look further into U96 here.
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Does U96 produce enough cash relative to debt?
U96’s debt level has been constant at around S$10b over the previous year including long-term debt. At this stable level of debt, the current cash and short-term investment levels stands at S$1.5b for investing into the business. Moreover, U96 has produced S$1.1b in operating cash flow in the last twelve months, resulting in an operating cash to total debt ratio of 11%, signalling that U96’s current level of operating cash is not high enough to cover debt. This ratio can also be a sign of operational efficiency as an alternative to return on assets. In U96’s case, it is able to generate 0.11x cash from its debt capital.
Can U96 meet its short-term obligations with the cash in hand?
Looking at U96’s S$5.4b in current liabilities, it appears that the company has been able to meet these obligations given the level of current assets of S$6.0b, with a current ratio of 1.1x. For Industrials companies, this ratio is within a sensible range as there’s enough of a cash buffer without holding too much capital in low return investments.
Can U96 service its debt comfortably?
With total debt exceeding equities, U96 is considered a highly levered company. This is not unusual for mid-caps as debt tends to be a cheaper and faster source of funding for some businesses. We can test if U96’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 U96, the ratio of 1.02x suggests that interest is not strongly covered, which means that debtors may be less inclined to loan the company more money, reducing its headroom for growth through debt.