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Can Petra Food Limited Hold Up in a Recession?

Singapore is no stranger to recessions. As such, a recession scenario can be something to think about before we invest.

Like much of the world, the Lion City’s economy suffered during the Global Financial Crisis of 2008-2009. In the third-quarter last year, Singapore had narrowly missed entering a technical recession. If history is a guide, it’s almost a certainty that there will be harder times for Singapore’s economy at some point in the future.

When that happens, we want to be sure that the companies we invest in can survive or even thrive.

Measuring the strength of the balance sheet

“We never want to count on the kindness of strangers in order to meet tomorrow’s obligations.”

– Warren Buffett

Having a strong balance sheet can be of great help to companies in meeting the demands of recessionary episodes. We can get a quick idea of a company’s balance sheet strength using two simple ratios.

Let’s run chocolate confectionery outfit Petra Foods Limited (SGX: P34) through both ratios today. We will be using the company’s figures for the quarter ended 30 September 2015.

The first is called the current ratio. A measure of just how much liquidity a company has, this number is simply a company’s current assets divided by its current liabilities.

Petra Foods’ Current Assets US$263 million
Petra Foods’ Current Liabilities US$120 million
Current Ratio 2.2

Source: Petra Foods’ earnings report

The current ratio that I’m generally looking out for is a figure that’s more than 1.5. With a current ratio of 2.2, Petra Foods should have no problem meeting its short-term financial obligations.

Close to half of Petra Foods’ current assets consists of its cash position. As of 30 September 2015, the chocolate maker had U$122.6 million in cash and equivalents and US$79.4 million in total borrowings.

Let’s now look at the second ratio: the quick ratio.

It is similar to the current ratio, but it takes the company’s inventory out of the equation. This is because inventories may not always be worth the amount that are recorded in the books. By removing inventory from the picture, you can find out if a company really has sufficient liquid assets to meet short-term operating needs.

Petra Foods’ Current Assets US$263 million
Petra Foods’ Current Liabilities US$120 million
Petra Foods’ Inventory US$63.1 million
Quick Ratio 1.67

Source: Petra Foods’ earnings report

In general, I prefer to see a quick ratio that is above 1. So as you can tell, Petra Foods has managed to clear the hurdle here again.

But despite clearing both hurdles, Petra Foods has its work cut out for it. The company’s revenue for the first nine months of 2015 had slipped by as much as 28.4% year-on-year on the back of a weaker Indonesian economy. Indonesia is Petra Foods’ main geographical market, accounting for 72% of total revenue in 2014. With this in mind, Petra Foods will need to find the best use for its cash position.

Foolish summary

The two ratios above give you a hint on how Petra Foods is able to finance its current obligations when they become due.

They represent useful starting points, but further study is required to understand whether the company’s business is really able to sustain itself when a recession comes knocking on the door.

(Learn how to calculate the current ratio and quick ratio here.)

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Chin Hui Leong doesn’t own shares in any companies mentioned.