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While small-cap stocks, such as DaChan Food (Asia) Limited (HKG:3999) with its market cap of HK$426.5m, are popular for their explosive growth, investors should also be aware of their balance sheet to judge whether the company can survive a downturn. Evaluating financial health as part of your investment thesis is essential, since poor capital management may bring about bankruptcies, which occur at a higher rate for small-caps. Here are few basic financial health checks you should consider before taking the plunge. Nevertheless, since I only look at basic financial figures, I recommend you dig deeper yourself into 3999 here.
Does 3999 produce enough cash relative to debt?
Over the past year, 3999 has ramped up its debt from CN¥953.2m to CN¥1.15b – this includes both the current and long-term debt. With this rise in debt, 3999’s cash and short-term investments stands at CN¥493.5m for investing into the business. Additionally, 3999 has produced cash from operations of CN¥175.4m in the last twelve months, leading to an operating cash to total debt ratio of 15.3%, signalling that 3999’s operating cash is not sufficient to cover its debt. This ratio can also be a sign of operational efficiency as an alternative to return on assets. In 3999’s case, it is able to generate 0.15x cash from its debt capital.
Can 3999 meet its short-term obligations with the cash in hand?
Looking at 3999’s most recent CN¥1.31b 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 1.58x. Generally, for Food 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 3999 service its debt comfortably?
With debt reaching 62.9% of equity, 3999 may be thought of as relatively highly levered. This is not unusual for small-caps as debt tends to be a cheaper and faster source of funding for some businesses. We can check to see whether 3999 is able to meet its debt obligations by looking at the net interest coverage ratio. A company generating earnings before interest and tax (EBIT) at least three times its net interest payments is considered financially sound. In 3999’s, case, the ratio of 5.02x suggests that interest is appropriately covered, which means that debtors may be willing to loan the company more money, giving 3999 ample headroom to grow its debt facilities.
Next Steps:
3999’s debt and cash flow levels indicate room for improvement. Its cash flow coverage of less than a quarter of debt means that operating efficiency could be an issue. However, the company will be able to pay all of its upcoming liabilities from its current short-term assets. I admit this is a fairly basic analysis for 3999’s financial health. Other important fundamentals need to be considered alongside. I suggest you continue to research DaChan Food (Asia) to get a better picture of the stock by looking at: