Are Youyuan International Holdings Limited's (HKG:2268) Interest Costs Too High?

Simply Wall St

Sat, May 4, 2019, 7:51 PM

Investors are always looking for growth in small-cap stocks like Youyuan International Holdings Limited (HKG:2268), with a market cap of HK$3.0b. However, an important fact which most ignore is: how financially healthy is the business? Understanding the company's financial health becomes crucial, as mismanagement of capital can lead to bankruptcies, which occur at a higher rate for small-caps. The following basic checks can help you get a picture of the company's balance sheet strength. Nevertheless, this is not a comprehensive overview, so I suggest you dig deeper yourself into 2268 here.

2268’s Debt (And Cash Flows)

2268 has sustained its debt level by about CN¥2.2b over the last 12 months including long-term debt. At this constant level of debt, 2268's cash and short-term investments stands at CN¥520m to keep the business going. Moreover, 2268 has generated CN¥947m in operating cash flow in the last twelve months, resulting in an operating cash to total debt ratio of 44%, indicating that 2268’s debt is appropriately covered by operating cash.

Can 2268 pay its short-term liabilities?

With current liabilities at CN¥2.7b, it seems that the business has been able to meet these commitments with a current assets level of CN¥2.7b, leading to a 1x current account ratio. The current ratio is the number you get when you divide current assets by current liabilities. Generally, for Packaging companies, this is a reasonable ratio as there's enough of a cash buffer without holding too much capital in low return investments.

Is 2268’s debt level acceptable?

2268 is a relatively highly levered company with a debt-to-equity of 46%. This is somewhat unusual for small-caps companies, since lenders are often hesitant to provide attractive interest rates to less-established businesses. We can test if 2268’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 2268, the ratio of 5.74x suggests that interest is appropriately covered, which means that lenders may be inclined to lend more money to the company, as it is seen as safe in terms of payback.

Next Steps:

Although 2268’s debt level is towards the higher end of the spectrum, its cash flow coverage seems adequate to meet obligations which means its debt is being efficiently utilised. This may mean this is an optimal capital structure for the business, given that it is also meeting its short-term commitment. I admit this is a fairly basic analysis for 2268's financial health. Other important fundamentals need to be considered alongside. You should continue to research Youyuan International Holdings to get a more holistic view of the small-cap by looking at: