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You Might Like L'Occitane International S.A. (HKG:973) But Do You Like Its Debt?

Simply Wall St

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Investors are always looking for growth in small-cap stocks like L'Occitane International S.A. (HKG:973), with a market cap of HK$23b. However, an important fact which most ignore is: how financially healthy is the business? Evaluating financial health as part of your investment thesis is crucial, as mismanagement of capital can lead to bankruptcies, which occur at a higher rate for small-caps. We'll look at some basic checks that can form a snapshot the company’s financial strength. Nevertheless, these checks don't give you a full picture, so I’d encourage you to dig deeper yourself into 973 here.

Does 973 Produce Much Cash Relative To Its Debt?

973's debt levels surged from €88m to €578m over the last 12 months – this includes long-term debt. With this growth in debt, 973's cash and short-term investments stands at €144m to keep the business going. On top of this, 973 has generated cash from operations of €169m in the last twelve months, resulting in an operating cash to total debt ratio of 29%, indicating that 973’s current level of operating cash is high enough to cover debt.

Can 973 pay its short-term liabilities?

With current liabilities at €258m, the company has been able to meet these commitments with a current assets level of €555m, leading to a 2.15x current account ratio. The current ratio is the number you get when you divide current assets by current liabilities. Usually, for Personal Products companies, this is a suitable ratio since there's a sufficient cash cushion without leaving too much capital idle or in low-earning investments.

SEHK:973 Historical Debt, June 24th 2019

Is 973’s debt level acceptable?

With debt reaching 53% of equity, 973 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. No matter how high the company’s debt, if it can easily cover the interest payments, it’s considered to be efficient with its use of excess leverage. A company generating earnings before interest and tax (EBIT) at least three times its net interest payments is considered financially sound. In 973's case, the ratio of 42.14x suggests that interest is comfortably covered, which means that lenders may be inclined to lend more money to the company, as it is seen as safe in terms of payback.

Next Steps:

973’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 973's liquidity needs, this may be its optimal capital structure for the time being. I admit this is a fairly basic analysis for 973's financial health. Other important fundamentals need to be considered alongside. I suggest you continue to research L'Occitane International to get a better picture of the small-cap by looking at:

  1. Future Outlook: What are well-informed industry analysts predicting for 973’s future growth? Take a look at our free research report of analyst consensus for 973’s outlook.
  2. Valuation: What is 973 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 973 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.