Large-cap companies such as Wharf (Holdings) Limited (SEHK:4), with a market-capitalization of HK$80.31B, are much sought after by risk-averse investors who find diversified revenue streams and strong capital returns more comforting than explosive growth potential. But another key factor to consider when investing in 4 is its financial health. Why is it important? A major downturn in the energy industry has resulted in over 150 companies going bankrupt and has put more than 100 on the verge of a collapse, primarily due to excessive debt. Here are few basic financial health checks to judge whether a company fits the bill or there is an additional risk which you should consider before taking the plunge. See our latest analysis for 4
Does 4 face the risk of succumbing to its debt-load?
A debt-to-equity ratio threshold varies depending on what industry the company operates, since some requires more debt financing than others. As a rule of thumb, a financially healthy large-cap should have a ratio less than 40%. 4’s debt-to-equity ratio stands at 15.77%, which means the risk of facing a debt-overhang is very low. 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 (EBIT) at least three times its interest payments is considered financially sound. In 4’s case, its interest is excessively covered by its earnings as the ratio sits at 12.61x. This means lenders may be inclined to lend more money to the company, as it is seen as safe in terms of payback.
How does 4’s operating cash flow stack up against its debt?
A simple way to determine whether the company has put debt into good use is to look at its operating cash flow against its debt obligation. This is also a test for whether 4 has the ability to repay its debt with cash from its business, which is less of a concern for large companies. In the case of 4, operating cash flow turned out to be 0.43x its debt level over the past twelve months. This is a good sign, as over a quarter of 4’s near term debt can be covered by its day-to-day cash income, which reduces its riskiness to its debtholders.
Next Steps:
Are you a shareholder? 4’s relatively safe debt levels is even more impressive due to its ability to generate high cash flow, which illustrates operating efficiency. Since 4’s financial position may change over time, You should continue examining market expectations for 4’s future growth on our free analysis platform.
Are you a potential investor? Although understanding the serviceability of debt is important when evaluating which companies are viable investments, it shouldn’t be the deciding factor. After all, debt financing is an important source of funding for companies seeking to grow through new projects and investments. As for next steps, I encourage potential investors to look at 4’s Return on Capital Employed (ROCE) in order to see management’s track record at deploying funds in high-returning projects.
To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned.