With a market capitalization of HK$111.51B, Metallurgical Corporation of China Ltd (SEHK:1618) falls in the category of stocks popularly identified as large-caps. These are established companies that attract investors due to diversified revenue streams and ability to enhance total returns through dividends. However, another important aspect of investing in large caps is its financial health. Why is it important? A major downturn in the energy industry has resulted in over 150 companies going bankrupt and has put more than 100 on the verge of a collapse, primarily due to excessive debt. Thus, it becomes utmost important for an investor to test a company’s resilience for such contingencies. In simple terms, I believe these three small calculations tell most of the story you need to know. Check out our latest analysis for Metallurgical of China
Does 1618 face the risk of succumbing to its debt-load?
A debt-to-equity ratio threshold varies depending on what industry the company operates, since some requires more debt financing than others. As a rule of thumb, a financially healthy large-cap should have a ratio less than 40%. In the case of 1618, the debt-to-equity ratio is over 100%, which means that it is a highly leveraged company. This is not a problem if the company has consistently grown its profits. But during a business downturn, as liquidity may dry up, making it hard to operate. While debt-to-equity ratio has several factors at play, an easier way to check whether 1618’s leverage is at a sustainable level is to check its ability to service the debt. A company generating earnings (EBIT) at least three times its interest payments is considered financially sound. 1618’s profits amply covers interest at 3.77 times, which is seen as relatively safe. Lenders may be less hesitant to lend out more funding as 1618’s high interest coverage is seen as responsible and safe practice.
Does 1618 generate an acceptable amount of cash through operations?
A basic way to evaluate 1618’s debt management is to see whether the cash flow generated from the business is at a relatively high level compared to the debt capital invested. This also assesses 1618’s debt repayment capacity, which is not a big concern for a large company. Last year, 1618’s operating cash flow was 0.07x its current debt. An annual operating cash flow of less than a tenth of the overall debt raises red flags, although short-term obstacles and business cyclicality may temporarily impact 1618’s ability to generate cash.
Next Steps:
Are you a shareholder? With a high level of debt on its balance sheet, 1618 could still be in a financially strong position if its cash flow also stacked up. However, this isn’t the case so investors should ask themselves if they believe 1618 can sustainably increase its operational efficiency going forward. Given that 1618’s financial position could change, You should continue examining market expectations for 1618’s future growth on our free analysis platform.