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Far East Global Group Limited (HKG:830) is a small-cap stock with a market capitalization of HK$1.3b. 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? Evaluating financial health as part of your investment thesis is vital, 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. Though, I know these factors are very high-level, so I recommend you dig deeper yourself into 830 here.
How does 830’s operating cash flow stack up against its debt?
Over the past year, 830 has ramped up its debt from HK$577m to HK$619m , which is made up of current and long term debt. With this growth in debt, 830 currently has HK$423m remaining in cash and short-term investments , ready to deploy into the business. Moreover, 830 has generated HK$2m in operating cash flow in the last twelve months, resulting in an operating cash to total debt ratio of 0.4%, indicating that 830’s current level of operating cash is not high enough to cover debt. This ratio can also be a sign of operational efficiency as an alternative to return on assets. In 830’s case, it is able to generate 0.004x cash from its debt capital.
Does 830’s liquid assets cover its short-term commitments?
Looking at 830’s most recent HK$1.9b liabilities, it appears that the company has been able to meet these obligations given the level of current assets of HK$2.6b, with a current ratio of 1.35x. Usually, for Building companies, this is a suitable ratio as there’s enough of a cash buffer without holding too much capital in low return investments.
Can 830 service its debt comfortably?
830 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. We can check to see whether 830 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 830’s, case, the ratio of 11.36x suggests that interest is comfortably covered, which means that lenders may be inclined to lend more money to the company, as it is seen as safe in terms of payback.
Next Steps:
830’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. This is only a rough assessment of financial health, and I’m sure 830 has company-specific issues impacting its capital structure decisions. You should continue to research Far East Global Group to get a more holistic view of the stock by looking at: