While small-cap stocks, such as Kwality Limited (NSE:KWALITY) with its market cap of ₹2.3b, are popular for their explosive growth, investors should also be aware of their balance sheet to judge whether the company can survive a downturn. So, understanding the company’s financial health becomes essential, as mismanagement of capital can lead to bankruptcies, which occur at a higher rate for small-caps. Here are few basic financial health checks you should consider before taking the plunge. Nevertheless, I know these factors are very high-level, so I’d encourage you to dig deeper yourself into KWALITY here.
Does KWALITY produce enough cash relative to debt?
Over the past year, KWALITY has ramped up its debt from ₹17b to ₹18b – this includes long-term debt. With this growth in debt, the current cash and short-term investment levels stands at ₹648m for investing into the business. Additionally, KWALITY has produced cash from operations of ₹855m over the same time period, resulting in an operating cash to total debt ratio of 4.7%, signalling that KWALITY’s current level of operating cash is not high enough to cover debt. This ratio can also be a sign of operational efficiency as an alternative to return on assets. In KWALITY’s case, it is able to generate 0.047x cash from its debt capital.
Does KWALITY’s liquid assets cover its short-term commitments?
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. For Food companies, this ratio is within a sensible range as there’s enough of a cash buffer without holding too much capital in low return investments.
Does KWALITY face the risk of succumbing to its debt-load?
Since total debt levels have outpaced equities, KWALITY is a highly leveraged company. This is not unusual for small-caps as debt tends to be a cheaper and faster source of funding for some businesses. 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.
Next Steps:
KWALITY’s high cash coverage means that, although its debt levels are high, the company is able to utilise its borrowings efficiently in order to generate cash flow. 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.
To help readers see past 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. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.