Stocks with market capitalization between $2B and $10B, such as Zhongsheng Group Holdings Limited (SEHK:881) with a size of HK$39.22B, do not attract as much attention from the investing community as do the small-caps and large-caps. While they are less talked about as an investment category, mid-cap risk-adjusted returns have generally been better than more commonly focused stocks that fall into the small- or large-cap categories. I will take you through a few basic checks to assess the financial health of companies with no debt. Check out our latest analysis for Zhongsheng Group Holdings
Can 881 service its debt comfortably?
While ideally the debt-to equity ratio of a financially healthy company should be less than 40%, several factors such as industry life-cycle and economic conditions can result in a company raising a significant amount of debt. In the case of 881, the debt-to-equity ratio is over 100%, which indicates that the company is holding a high level of debt relative to its net worth. In the event of financial turmoil, the company may experience difficulty meeting interest and other debt obligations. We can test if 881’s debt levels are sustainable by measuring interest payments against earnings of a company. Ideally, earnings (EBIT) should cover interest by at least three times, therefore reducing concerns when profit is highly volatile. 881’s profits amply covers interest at 4.87 times, which is seen as relatively safe. Debtors may be willing to loan the company more money, giving 881 ample headroom to grow its debt facilities.
Can 881 meet its short-term obligations with the cash in hand?
Debt to equity ratio is an important aspect of financial strength. But if the company has a substantial amount of cash on its balance sheet, that should allay some fear of a debt overhang and increase the chance of meeting upcoming liabilities. To assess this, I compare 881’s cash and other liquid assets against its upcoming debt. Our analysis shows that 881 does have enough liquid assets on hand to meet its upcoming liabilities, which lowers our concerns should adverse events arise.
Next Steps:
Are you a shareholder? 881’s high debt levels are not met with high cash flow coverage. This means investors should ask themselves if they think 881 can improve in terms of debt management and operational efficiency. Since 881’s financial situation could change, I encourage assessing market expectations for 881’s future growth on our free analysis platform.
Are you a potential investor? While investors should analyse the serviceability of debt, it shouldn’t be viewed in isolation of other factors. After all, debt is often used to fund or accelerate new projects that are expected to improve a company’s growth trajectory in the longer term. 881’s Return on Capital Employed (ROCE) in order to see management’s track record at deploying funds in high-returning projects.
To help readers see pass 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.