Investors are always looking for growth in small-cap stocks like CST Group Limited (HKG:985), with a market cap of HK$1.0b. However, an important fact which most ignore is: how financially healthy is the business? Since 985 is loss-making right now, it’s essential to assess 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. Nevertheless, this commentary is still very high-level, so I suggest you dig deeper yourself into 985 here.

Does 985 produce enough cash relative to debt?

Over the past year, 985 has ramped up its debt from US$14m to US$422m – this includes long-term debt. With this rise in debt, the current cash and short-term investment levels stands at US$407m , ready to deploy into the business. Moving onto cash from operations, its small level of operating cash flow means calculating cash-to-debt wouldn’t be too useful, though these low levels of cash means that operational efficiency is worth a look. As the purpose of this article is a high-level overview, I won’t be looking at this today, but you can take a look at some of 985’s operating efficiency ratios such as ROA here.

Can 985 meet its short-term obligations with the cash in hand?

At the current liabilities level of US$28m, the company has been able to meet these commitments with a current assets level of US$539m, leading to a 19.23x current account ratio. However, a ratio above 3x may be considered excessive by some investors.

Is 985’s debt level acceptable?

985 is a relatively highly levered company with a debt-to-equity of 60%. This is not uncommon for a small-cap company given that debt tends to be lower-cost and at times, more accessible. But since 985 is currently unprofitable, sustainability of its current state of operations becomes a concern. Running high debt, while not yet making money, can be risky in unexpected downturns as liquidity may dry up, making it hard to operate.

Next Steps:

985’s high cash coverage means that, although its debt levels are high, the company is able to utilise its borrowings efficiently in order to generate cash flow. Since there is also no concerns around 985’s liquidity needs, this may be its optimal capital structure for the time being. Keep in mind I haven’t considered other factors such as how 985 has been performing in the past. I recommend you continue to research CST Group to get a better picture of the small-cap by looking at:

1. Historical Performance: What has 985’s returns been like over the past? Go into more detail in the past track record analysis and take a look at the free visual representations of our analysis for more clarity.

2. 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 past 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. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.