What does China Foods Limited’s (HKG:506) Balance Sheet Tell Us About Its Future?

Want to participate in a short research study? Help shape the future of investing tools and receive a $20 prize!

Investors are always looking for growth in small-cap stocks like China Foods Limited (HKG:506), with a market cap of HK$8.9b. However, an important fact which most ignore is: how financially healthy is the business? So, understanding the company’s financial health becomes crucial, since poor capital management may bring about bankruptcies, which occur at a higher rate for small-caps. I believe these basic checks tell most of the story you need to know. Nevertheless, I know these factors are very high-level, so I suggest you dig deeper yourself into 506 here.

How much cash does 506 generate through its operations?

Over the past year, 506 has reduced its debt from CN¥3.7b to CN¥1.8b , which includes long-term debt. With this reduction in debt, 506 currently has CN¥487m remaining in cash and short-term investments , ready to deploy into the business. Additionally, 506 has generated CN¥726m in operating cash flow during the same period of time, resulting in an operating cash to total debt ratio of 41%, indicating that 506’s operating cash is sufficient to cover its debt. This ratio can also be interpreted as a measure of efficiency as an alternative to return on assets. In 506’s case, it is able to generate 0.41x cash from its debt capital.

Does 506’s liquid assets cover its short-term commitments?

Looking at 506’s CN¥5.1b in current liabilities, it seems that the business arguably has a rather low level of current assets relative its obligations, with the current ratio last standing at 0.63x.

SEHK:506 Historical Debt, February 21st 2019
SEHK:506 Historical Debt, February 21st 2019

Can 506 service its debt comfortably?

506’s level of debt is appropriate relative to its total equity, at 27%. This range is considered safe as 506 is not taking on too much debt obligation, which can be restrictive and risky for equity-holders. We can test if 506’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 506, the ratio of 6.18x suggests that interest is appropriately covered, which means that debtors may be willing to loan the company more money, giving 506 ample headroom to grow its debt facilities.

Next Steps:

506’s high cash coverage and appropriate debt levels indicate its ability to utilise its borrowings efficiently in order to generate ample cash flow. Though its low liquidity raises concerns over whether current asset management practices are properly implemented for the small-cap. Keep in mind I haven’t considered other factors such as how 506 has been performing in the past. I recommend you continue to research China Foods to get a better picture of the stock by looking at:

  1. Future Outlook: What are well-informed industry analysts predicting for 506’s future growth? Take a look at our free research report of analyst consensus for 506’s outlook.
  2. Valuation: What is 506 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 506 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.