Monday, May 12, 2008

Hongguo - Financial health

Financial health of Hongguo

In the midst of analyzing the ROE, I’ve calculated the financial leverage ratio. Financial leverage ratio gives a good feel of the amount of leverage used. The figures are as shown:

Financial leverage---------Year

Judging from the ratios, we can see that Hongguo isn’t overly extending itself. In fact, it should be less leveraged as the years go by. Let’s take a closer look to see if the financial status of Hongguo is as shown by the financial leverage ratio shown above.

Debt to Equity (total liabilities/share holder’s equity)

Debt to equity of Hongguo decreases steadily from 2002 to 2007, which is what is suggested by the financial leverage ratio. Looking at the balance sheet, there are only two years, 2003 and 2004, in which Hongguo had long term liabilities in the form of term loans. After that, there are no more long term liabilities.

On the other hand, Prime has a higher Debt/equity ratio (about twice as much) than Hongguo. This can also be seen by their higher financial leverage ratio shown in earlier post. Belle is harder to tell, since there is only one year since listing to compare.

On the whole, I’m very satisfied with the debt/equity that Hongguo has. It’s the second lowest among the three. A debt/equity averaging 0.43 since listing in 2003 is definitely not a sign to worry about.

Current and Quick ratio

Current ratio of Hongguo shows a slight downtrend. Considering that in FY07, its current assets are more than enough to pay off its current liabilities 2.77 times, I’m hardly worried. Even a more conservative quick ratio suggest that in the same year, the current assets without taking into account Hongguo’s inventories can pay off its current liabilities 1.46 times. Since Hongguo only has current liabilities, I think we can safely give Hongguo a clean bill of financial health.

Prime has a lower current ratio and quick ratio, with quick ratio less than 1 throughout the years. While I don’t think it is having any insolvency issues near term, I dare say that Hongguo has a stronger balance sheet than Prime. Belle has a rather strange current and quick ratio, but let’s not bother too much into it for now.

To add the cake to the icing, let’s take a look at the amount of cash that each company holds as a percentage to their total assets.

Cash/Total assets (%)--------02--------03--------04-------05-------06-------07
Prime Success----------------16.8------18.0------11.8-----10.2------8.7-------7.7

I’ve a feeling that Hongguo management wanted to grow, but at a sustainable pace backed by a series of successful points of sales (POS) and funded by their own internal cash flow generated. They can borrow from banks to really aggressively open up new stores, but they didn’t. In fact, they are sitting on around 10% cash out of their total assets. While this might hinder their growth somewhat by not aggressively pursuing an all out approach to expand, I believe this prudence will bring about a longer and more sustainable growth in their business over time.

Here’s Hongguo’s financial health report – a strong balance sheet with around 60% equities and 40% debts on average, no long term liabilities or bank borrowings in recent years and with enough assets to pay off their liabilities at least 1.5 times over. I’m more than satisfied with them.