Investors are always looking for growth in small-cap stocks like Chiho Environmental Group Limited (SEHK:976), with a market cap of HK$6.32B. However, an important fact which most ignore is: how financially healthy is the business? Given that 976 is not presently profitable, it’s crucial to understand the current state of its operations and pathway to profitability. Here are a few basic checks that are good enough to have a broad overview of the company’s financial strength. Though, this commentary is still very high-level, so I suggest you dig deeper yourself into 976 here.

Does 976 generate an acceptable amount of cash through operations?

Over the past year, 976 has ramped up its debt from HK$1.36B to HK$5.25B , which comprises of short- and long-term debt. With this growth in debt, 976’s cash and short-term investments stands at HK$2.04B , ready to deploy into the business. On top of this, 976 has generated cash from operations of HK$56.40M over the same time period, resulting in an operating cash to total debt ratio of 1.07%, indicating that 976’s debt is not appropriately covered by operating cash. This ratio can also be interpreted as a measure of efficiency for unprofitable businesses as traditional metrics such as return on asset (ROA) requires positive earnings. In 976’s case, it is able to generate 0.011x cash from its debt capital.

Can 976 pay its short-term liabilities?

Looking at 976’s most recent HK$5.09B liabilities, it appears that the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 1.26x. Generally, for Metals and Mining companies, this is a reasonable ratio since there is a bit of a cash buffer without leaving too much capital in a low-return environment.

Can 976 service its debt comfortably?

976 is a highly-leveraged company with debt exceeding equity by over 100%. This is not unusual for small-caps as debt tends to be a cheaper and faster source of funding for some businesses. But since 976 is presently unprofitable, sustainability of its current state of operations becomes a concern. Maintaining a high level of debt, while revenues are still below costs, can be dangerous as liquidity tends to dry up in unexpected downturns.

Next Steps:

At its current level of cash flow coverage, 976 has room for improvement to better cushion for events which may require debt repayment. However, the company exhibits an ability to meet its near term obligations should an adverse event occur. This is only a rough assessment of financial health, and I’m sure 976 has company-specific issues impacting its capital structure decisions. You should continue to research Chiho Environmental Group to get a better picture of the stock by looking at: