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Investors are always looking for growth in small-cap stocks like China Energy Engineering Corporation Limited (HKG:3996), with a market cap of HK$27b. However, an important fact which most ignore is: how financially healthy is the business? Understanding the company's financial health becomes vital, as mismanagement of capital can lead to bankruptcies, which occur at a higher rate for small-caps. We'll look at some basic checks that can form a snapshot the company’s financial strength. Nevertheless, this is just a partial view of the stock, and I recommend you dig deeper yourself into 3996 here.
Does 3996 Produce Much Cash Relative To Its Debt?
3996's debt levels surged from CN¥76b to CN¥84b over the last 12 months , which includes long-term debt. With this rise in debt, 3996's cash and short-term investments stands at CN¥45b , ready to be used for running the business. On top of this, 3996 has produced CN¥16b in operating cash flow during the same period of time, resulting in an operating cash to total debt ratio of 19%, meaning that 3996’s current level of operating cash is not high enough to cover debt.
Can 3996 meet its short-term obligations with the cash in hand?
At the current liabilities level of CN¥215b, the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 1.16x. The current ratio is calculated by dividing current assets by current liabilities. For Construction companies, this ratio is within a sensible range since there is a bit of a cash buffer without leaving too much capital in a low-return environment.
Does 3996 face the risk of succumbing to its debt-load?
With a debt-to-equity ratio of 87%, 3996 can be considered as an above-average leveraged company. This is a bit unusual for a small-cap stock, since they generally have a harder time borrowing than large more established companies. We can check to see whether 3996 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 3996's, case, the ratio of 4.18x suggests that interest is appropriately covered, which means that lenders may be willing to lend out more funding as 3996’s high interest coverage is seen as responsible and safe practice.
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3996’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 3996'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 3996 has been performing in the past. I recommend you continue to research China Energy Engineering to get a more holistic view of the small-cap by looking at: