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Zhengye International Holdings Company Limited (SEHK:3363) is a small-cap stock with a market capitalization of HK$880.00M. 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, since poor capital management may bring about bankruptcies, which occur at a higher rate for small-caps. Here are few basic financial health checks you should consider before taking the plunge. Nevertheless, I know these factors are very high-level, so I recommend you dig deeper yourself into 3363 here.
Does 3363 generate enough cash through operations?
Over the past year, 3363 has ramped up its debt from CN¥845.77M to CN¥925.49M , which comprises of short- and long-term debt. With this growth in debt, 3363 currently has CN¥190.27M remaining in cash and short-term investments for investing into the business. Moving onto cash from operations, its small level of operating cash flow means calculating cash-to-debt wouldn’t be too useful, though these low levels of cash means that operational efficiency is worth a look. As the purpose of this article is a high-level overview, I won’t be looking at this today, but you can examine some of 3363’s operating efficiency ratios such as ROA here.
Can 3363 meet its short-term obligations with the cash in hand?
With current liabilities at CN¥1.42B, it appears that the company has been able to meet these obligations given the level of current assets of CN¥1.49B, with a current ratio of 1.04x. Generally, for Packaging companies, this is a reasonable ratio since there is a bit of a cash buffer without leaving too much capital in a low-return environment.
Is 3363’s debt level acceptable?
3363 is a relatively highly levered company with a debt-to-equity of 93.12%. This is not uncommon for a small-cap company given that debt tends to be lower-cost and at times, more accessible. 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 3363’s case, the ratio of 6.3x suggests that interest is appropriately 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.