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Are Shui On Land Limited's (HKG:272) Interest Costs Too High?

Simply Wall St

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Shui On Land Limited (HKG:272) is a small-cap stock with a market capitalization of HK$15b. While investors primarily focus on the growth potential and competitive landscape of the small-cap companies, they end up ignoring a key aspect, which could be the biggest threat to its existence: its financial health. Why is it important? Evaluating financial health as part of your investment thesis is vital, 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 just a partial view of the stock, and I’d encourage you to dig deeper yourself into 272 here.

Does 272 Produce Much Cash Relative To Its Debt?

272's debt levels have fallen from CN¥43b to CN¥36b over the last 12 months – this includes long-term debt. With this debt payback, 272 currently has CN¥13b remaining in cash and short-term investments , ready to be used for running the business. Additionally, 272 has generated cash from operations of CN¥11b in the last twelve months, leading to an operating cash to total debt ratio of 32%, indicating that 272’s current level of operating cash is high enough to cover debt.

Can 272 pay its short-term liabilities?

Looking at 272’s CN¥36b in current liabilities, it appears that the company has been able to meet these commitments with a current assets level of CN¥40b, leading to a 1.1x current account ratio. The current ratio is the number you get when you divide current assets by current liabilities. Generally, for Real Estate companies, this is a reasonable ratio as there's enough of a cash buffer without holding too much capital in low return investments.

SEHK:272 Historical Debt, July 22nd 2019

Can 272 service its debt comfortably?

With a debt-to-equity ratio of 76%, 272 can be considered as an above-average leveraged 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 test if 272’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 272, the ratio of 6.2x suggests that interest is appropriately covered, which means that debtors may be willing to loan the company more money, giving 272 ample headroom to grow its debt facilities.

Next Steps:

272’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. 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 272 has company-specific issues impacting its capital structure decisions. I suggest you continue to research Shui On Land to get a more holistic view of the small-cap by looking at:

  1. Future Outlook: What are well-informed industry analysts predicting for 272’s future growth? Take a look at our free research report of analyst consensus for 272’s outlook.
  2. Valuation: What is 272 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 272 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.