Are China Merchants Land Limited's (HKG:978) Interest Costs Too High?
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While small-cap stocks, such as China Merchants Land Limited (HKG:978) with its market cap of HK$5.7b, 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, as mismanagement of capital can lead to 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. However, this is not a comprehensive overview, so I suggest you dig deeper yourself into 978 here.
Does 978 Produce Much Cash Relative To Its Debt?
978's debt levels surged from CN¥19b to CN¥23b over the last 12 months , which accounts for long term debt. With this rise in debt, 978's cash and short-term investments stands at CN¥6.9b to keep the business going. Moreover, 978 has produced CN¥1.3b in operating cash flow during the same period of time, resulting in an operating cash to total debt ratio of 5.4%, meaning that 978’s debt is not covered by operating cash.
Does 978’s liquid assets cover its short-term commitments?
With current liabilities at CN¥34b, it seems that the business has been able to meet these commitments with a current assets level of CN¥57b, leading to a 1.67x current account ratio. The current ratio is calculated by dividing current assets by current liabilities. For Real Estate companies, this ratio is within a sensible range since there's a sufficient cash cushion without leaving too much capital idle or in low-earning investments.
Is 978’s debt level acceptable?
With debt reaching 97% of equity, 978 may be thought of as relatively highly levered. 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 978’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 978, the ratio of 13.37x suggests that interest is comfortably covered, which means that debtors may be willing to loan the company more money, giving 978 ample headroom to grow its debt facilities.
Next Steps:
978’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. Since there is also no concerns around 978's liquidity needs, this may be its optimal capital structure for the time being. This is only a rough assessment of financial health, and I'm sure 978 has company-specific issues impacting its capital structure decisions. I recommend you continue to research China Merchants Land to get a better picture of the small-cap by looking at:
Future Outlook: What are well-informed industry analysts predicting for 978’s future growth? Take a look at our free research report of analyst consensus for 978’s outlook.
Valuation: What is 978 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 978 is currently mispriced by the market.
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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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.
