Li & Fung Limited (HKG:494): Time For A Financial Health Check

Want to participate in a short research study? Help shape the future of investing tools and you could win a $250 gift card!

While small-cap stocks, such as Li & Fung Limited (HKG:494) with its market cap of HK$9.7b, are popular for their explosive growth, investors should also be aware of their balance sheet to judge whether the company can survive a downturn. Assessing first and foremost the financial health is essential, as mismanagement of capital can lead to bankruptcies, which occur at a higher rate for small-caps. Let’s work through some financial health checks you may wish to consider if you’re interested in this stock. However, these checks don’t give you a full picture, so I’d encourage you to dig deeper yourself into 494 here.

494’s Debt (And Cash Flows)

Over the past year, 494 has ramped up its debt from US$779m to US$1.0b , which accounts for long term debt. With this growth in debt, 494’s cash and short-term investments stands at US$612m , ready to be used for running the business. On top of this, 494 has generated US$137m in operating cash flow in the last twelve months, resulting in an operating cash to total debt ratio of 13%, signalling that 494’s current level of operating cash is not high enough to cover debt.

Does 494’s liquid assets cover its short-term commitments?

At the current liabilities level of US$2.7b, it appears that the company has been able to meet these obligations given the level of current assets of US$2.8b, with a current ratio of 1.03x. The current ratio is calculated by dividing current assets by current liabilities. Usually, for Luxury companies, this is a suitable ratio since there is a bit of a cash buffer without leaving too much capital in a low-return environment.

SEHK:494 Historical Debt, June 11th 2019
SEHK:494 Historical Debt, June 11th 2019

Is 494’s debt level acceptable?

494 is a relatively highly levered company with a debt-to-equity of 55%. This is somewhat unusual for small-caps companies, since lenders are often hesitant to provide attractive interest rates to less-established businesses. We can check to see whether 494 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 494’s, case, the ratio of 5.61x suggests that interest is appropriately covered, which means that lenders may be willing to lend out more funding as 494’s high interest coverage is seen as responsible and safe practice.

Next Steps:

Although 494’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. Since there is also no concerns around 494’s liquidity needs, this may be its optimal capital structure for the time being. I admit this is a fairly basic analysis for 494’s financial health. Other important fundamentals need to be considered alongside. I recommend you continue to research Li & Fung to get a more holistic view of the small-cap by looking at:

  1. Future Outlook: What are well-informed industry analysts predicting for 494’s future growth? Take a look at our free research report of analyst consensus for 494’s outlook.
  2. Valuation: What is 494 worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether 494 is currently mispriced by the market.
  3. Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.