Will A Recession Harm Hour Glass Ltd?

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

At home, Singapore’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 the economies of Singapore and other parts of Asia 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 luxury watch retailer Hour Glass Ltd  (SGX: AGS) through both ratios today. It may be a pertinent thing to do considering that Hour Glass is in the business of dealing with luxury goods, whose demand may be more prone to large downswings during recessionary times.

In its fiscal year ended 31 March 2015, Hour Glass’s revenue had come mostly from South East Asia and North East Asia. We will be using the company’s figures for the quarter ended 31 December 2015.

The first ratio I’m interested in 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.

Hour Glass’s Current Assets S$434 million
Hour Glass’s Current Liabilities S$108 million
Current Ratio 4.0

Source: Hour Glass’s earnings report

I am looking for a current ratio of more than 1.5 in general. Hour Glass has a strong showing here given its current ratio of 4.

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.

Hour Glass’s Current Assets S$434 million
Hour Glass’s Current Liabilities S$108 million
Hour Glass’s Inventory S$346 million
Quick Ratio 0.8

Source: Hour Glass’s earnings report

In general, I want to see a quick ratio of over 1. As you can tell, Hour Glass has failed to clear the hurdle in this case.

Inventory makes up a large part of Hour Glass’s current assets. The onus is on the luxury watch retailer to keep driving its sales while keeping its inventory in check. Hour Glass’s inventory levels may be an important area for investors to keep an eye on.

Foolish summary

The two ratios above give you a hint on how Hour Glass 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.