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Investors are always looking for growth in small-cap stocks like Xiwang Special Steel Company Limited (HKG:1266), with a market cap of HK$3.81b. However, an important fact which most ignore is: how financially healthy is the business? Evaluating financial health as part of your investment thesis is crucial, as mismanagement of capital can lead to bankruptcies, which occur at a higher rate for small-caps. Here are a few basic checks that are good enough to have a broad overview of the company’s financial strength. However, this commentary is still very high-level, so I recommend you dig deeper yourself into 1266 here.
Does 1266 produce enough cash relative to debt?
1266’s debt levels have fallen from HK$5.26b to HK$4.31b over the last 12 months , which comprises of short- and long-term debt. With this debt payback, 1266 currently has HK$164.92m remaining in cash and short-term investments for investing into the business. On top of this, 1266 has generated cash from operations of HK$2.29b during the same period of time, resulting in an operating cash to total debt ratio of 53.10%, meaning that 1266’s debt is appropriately covered by operating cash. This ratio can also be interpreted as a measure of efficiency as an alternative to return on assets. In 1266’s case, it is able to generate 0.53x cash from its debt capital.
Does 1266’s liquid assets cover its short-term commitments?
At the current liabilities level of HK$5.41b liabilities, it appears that the company is not able to meet these obligations given the level of current assets of HK$1.87b, with a current ratio of 0.35x below the prudent level of 3x.
Is 1266’s debt level acceptable?
With debt reaching 83.77% of equity, 1266 may be thought of as relatively highly levered. This is not uncommon for a small-cap company given that debt tends to be lower-cost and at times, more accessible. We can check to see whether 1266 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 1266’s, case, the ratio of 4.41x suggests that interest is appropriately covered, which means that debtors may be willing to loan the company more money, giving 1266 ample headroom to grow its debt facilities.
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1266’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. But, its low liquidity raises concerns over whether current asset management practices are properly implemented for the small-cap. Keep in mind I haven’t considered other factors such as how 1266 has been performing in the past. I recommend you continue to research Xiwang Special Steel to get a more holistic view of the stock by looking at: