Courts Asia Limited (SGX:RE2) is a small-cap stock with a market capitalization of SGD159.68M. 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? Companies operating in the Specialty Retail industry facing headwinds from current disruption, even ones that are profitable, are more likely to be higher risk. So, understanding the company’s financial health becomes crucial. Here are few basic financial health checks you should consider before taking the plunge. Nevertheless, given that I have not delve into the company-specifics, I suggest you dig deeper yourself into RE2 here.

How does RE2’s operating cash flow stack up against its debt?

RE2’s debt levels have fallen from SGD372.0M to SGD304.4M over the last 12 months – this includes both the current and long-term debt. With this reduction in debt, RE2 currently has SGD98.7M remaining in cash and short-term investments for investing into the business. Additionally, RE2 has generated SGD45.5M in operating cash flow in the last twelve months, leading to an operating cash to total debt ratio of 14.95%, meaning that RE2’s debt is not appropriately covered by operating cash. This ratio can also be a sign of operational efficiency as an alternative to return on assets. In RE2’s case, it is able to generate 0.15x cash from its debt capital.

Can RE2 meet its short-term obligations with the cash in hand?

Looking at RE2’s most recent SGD184.2M 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 2.29x. Generally, for Specialty Retail 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 RE2 service its debt comfortably?

With total debt exceeding equities, RE2 is considered a highly levered company. This is not unusual for small-caps as debt tends to be a cheaper and faster source of funding for some businesses. No matter how high the company’s debt, if it can easily cover the interest payments, it’s considered to be efficient with its use of excess leverage. A company generating earnings after interest and tax at least three times its net interest payments is considered financially sound. In RE2’s case, the ratio of 2.11x suggests that interest is not strongly covered, which means that lenders may be more reluctant to lend out more funding as RE2’s low interest coverage already puts the company at higher risk of default.

Next Steps:

RE2’s cash flow coverage indicates it could improve its operating efficiency in order to meet demand for debt repayments should unforeseen events arise. However, its high liquidity ensures the company will continue to operate smoothly should unfavourable circumstances arise. Keep in mind I haven’t considered other factors such as how RE2 has been performing in the past. I suggest you continue to research Courts Asia to get a more holistic view of the stock by looking at:

• 1. Future Outlook: What are well-informed industry analysts predicting for RE2’s future growth? Take a look at our free research report of analyst consensus for RE2’s outlook.

• 2. Valuation: What is RE2 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 RE2 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.

To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned.