While small-cap stocks, such as Health and Happiness (H&H) International Holdings Limited (HKG:1112) with its market cap of HK$29b, are popular for their explosive growth, investors should also be aware of their balance sheet to judge whether the company can survive a downturn. Understanding the company's financial health becomes crucial, as mismanagement of capital can lead to bankruptcies, which occur at a higher rate for small-caps. The following basic checks can help you get a picture of the company's balance sheet strength. Nevertheless, these checks don't give you a full picture, so I’d encourage you to dig deeper yourself into 1112 here.

1112’s Debt (And Cash Flows)

Over the past year, 1112 has reduced its debt from CN¥6.3b to CN¥6.0b , which includes long-term debt. With this debt payback, the current cash and short-term investment levels stands at CN¥1.9b , ready to be used for running the business. On top of this, 1112 has generated cash from operations of CN¥1.7b over the same time period, leading to an operating cash to total debt ratio of 28%, indicating that 1112’s debt is appropriately covered by operating cash.

Can 1112 pay its short-term liabilities?

With current liabilities at CN¥3.2b, it seems that the business has been able to meet these obligations given the level of current assets of CN¥4.5b, with a current ratio of 1.42x. The current ratio is calculated by dividing current assets by current liabilities. Usually, for Food companies, this is a suitable ratio as there's enough of a cash buffer without holding too much capital in low return investments.

Does 1112 face the risk of succumbing to its debt-load?

1112 is a highly-leveraged company with debt exceeding equity by over 100%. This is somewhat unusual for small-caps companies, since lenders are often hesitant to provide attractive interest rates to less-established businesses. We can test if 1112’s debt levels are sustainable by measuring interest payments against earnings of a company. Ideally, earnings before interest and tax (EBIT) should cover net interest by at least three times. For 1112, the ratio of 5.69x suggests that interest is appropriately covered, which means that lenders may be willing to lend out more funding as 1112’s high interest coverage is seen as responsible and safe practice.

Next Steps:

Although 1112’s debt level is towards the higher end of the spectrum, its cash flow coverage seems adequate to meet obligations which means its debt is being efficiently utilised. Since there is also no concerns around 1112's liquidity needs, this may be its optimal capital structure for the time being. This is only a rough assessment of financial health, and I'm sure 1112 has company-specific issues impacting its capital structure decisions. I suggest you continue to research Health and Happiness (H&H) International Holdings to get a more holistic view of the small-cap by looking at: