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Hao Bai International (Cayman) Limited (HKG:8431) is a small-cap stock with a market capitalization of HK$140m. 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 essential, as mismanagement of capital can lead to bankruptcies, which occur at a higher rate for small-caps. I believe these basic checks tell most of the story you need to know. Nevertheless, this commentary is still very high-level, so I suggest you dig deeper yourself into 8431 here.
Does 8431 produce enough cash relative to debt?
8431 has built up its total debt levels in the last twelve months, from HK$28m to HK$49m – this includes long-term debt. With this growth in debt, 8431 currently has HK$34m remaining in cash and short-term investments for investing into the business. Moreover, 8431 has produced HK$2.0m in operating cash flow during the same period of time, resulting in an operating cash to total debt ratio of 4.0%, signalling that 8431’s debt is not appropriately covered by operating cash. This ratio can also be a sign of operational efficiency as an alternative to return on assets. In 8431’s case, it is able to generate 0.04x cash from its debt capital.
Does 8431’s liquid assets cover its short-term commitments?
With current liabilities at HK$66m, it appears that the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 2.67x. Generally, for Construction companies, this is a reasonable ratio as there’s enough of a cash buffer without holding too much capital in low return investments.
Can 8431 service its debt comfortably?
With a debt-to-equity ratio of 50%, 8431 can be considered as an above-average leveraged company. This is not unusual for small-caps as debt tends to be a cheaper and faster source of funding for some businesses. No matter how high the company’s debt, if it can easily cover the interest payments, it’s considered to be efficient with its use of excess leverage. A company generating earnings after interest and tax at least three times its net interest payments is considered financially sound. In 8431’s case, the ratio of 4.88x suggests that interest is appropriately covered, which means that lenders may be less hesitant to lend out more funding as 8431’s high interest coverage is seen as responsible and safe practice.