While small-cap stocks, such as Kwality Limited (NSE:KWALITY) with its market cap of ₹1.6b, are popular for their explosive growth, investors should also be aware of their balance sheet to judge whether the company can survive a downturn. Understanding the company’s financial health becomes essential, since poor capital management may bring about 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, potential investors would need to take a closer look, and I’d encourage you to dig deeper yourself into KWALITY here.
Does KWALITY Produce Much Cash Relative To Its Debt?
KWALITY has built up its total debt levels in the last twelve months, from ₹17b to ₹18b , which accounts for long term debt. With this rise in debt, KWALITY currently has ₹648m remaining in cash and short-term investments to keep the business going. On top of this, KWALITY has produced ₹855m in operating cash flow in the last twelve months, resulting in an operating cash to total debt ratio of 4.7%, signalling that KWALITY’s operating cash is less than its debt.
Can KWALITY pay its short-term liabilities?
At the current liabilities level of ₹17b, it seems that the business has been able to meet these obligations given the level of current assets of ₹28b, with a current ratio of 1.62x. The current ratio is calculated by dividing current assets by current liabilities. Usually, for Food companies, this is a suitable ratio as there’s enough of a cash buffer without holding too much capital in low return investments.
Can KWALITY service its debt comfortably?
KWALITY is a highly-leveraged company with debt exceeding equity by over 100%. This is a bit unusual for a small-cap stock, since they generally have a harder time borrowing than large more established companies. We can test if KWALITY’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 KWALITY, the ratio of 1.92x 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.
Although KWALITY’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. This is only a rough assessment of financial health, and I’m sure KWALITY has company-specific issues impacting its capital structure decisions. I recommend you continue to research Kwality to get a more holistic view of the small-cap by looking at:
- Historical Performance: What has KWALITY’s returns been like over the past? Go into more detail in the past track record analysis and take a look at the free visual representations of our analysis for more clarity.
- 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.
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