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Are Japfa Ltd.'s (SGX:UD2) Interest Costs Too High?

Simply Wall St

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Investors are always looking for growth in small-cap stocks like Japfa Ltd. (SGX:UD2), with a market cap of S$1.0b. However, an important fact which most ignore is: how financially healthy is the business? Understanding the company's financial health becomes crucial, 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. However, potential investors would need to take a closer look, and I’d encourage you to dig deeper yourself into UD2 here.

Does UD2 Produce Much Cash Relative To Its Debt?

UD2 has built up its total debt levels in the last twelve months, from US$935m to US$1.4b – this includes long-term debt. With this increase in debt, UD2's cash and short-term investments stands at US$147m , ready to be used for running the business. Moreover, UD2 has generated cash from operations of US$214m in the last twelve months, resulting in an operating cash to total debt ratio of 15%, indicating that UD2’s debt is not covered by operating cash.

Can UD2 meet its short-term obligations with the cash in hand?

Looking at UD2’s US$922m in current liabilities, it appears that the company has been able to meet these commitments with a current assets level of US$1.4b, leading to a 1.49x current account ratio. The current ratio is the number you get when you divide current assets by current liabilities. For Food companies, this ratio is within a sensible range since there is a bit of a cash buffer without leaving too much capital in a low-return environment.

SGX:UD2 Historical Debt, June 17th 2019

Is UD2’s debt level acceptable?

With total debt exceeding equity, UD2 is considered a highly levered company. 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 check to see whether UD2 is able to meet its debt obligations by looking at the net interest coverage ratio. A company generating earnings before interest and tax (EBIT) at least three times its net interest payments is considered financially sound. In UD2's, case, the ratio of 3.87x suggests that interest is appropriately covered, which means that lenders may be willing to lend out more funding as UD2’s high interest coverage is seen as responsible and safe practice.

Next Steps:

Although UD2’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 UD2 has company-specific issues impacting its capital structure decisions. You should continue to research Japfa to get a more holistic view of the small-cap by looking at:

  1. Future Outlook: What are well-informed industry analysts predicting for UD2’s future growth? Take a look at our free research report of analyst consensus for UD2’s outlook.
  2. Valuation: What is UD2 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 UD2 is currently mispriced by the market.
  3. 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.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

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.