While small-cap stocks, such as Golden Eagle Retail Group Limited (HKG:3308) with its market cap of HK$14.0b, are popular for their explosive growth, investors should also be aware of their balance sheet to judge whether the company can survive a downturn. Companies operating in the Multiline Retail industry facing headwinds from current disruption, even ones that are profitable, tend to be high risk. Evaluating financial health as part of your investment thesis is vital. Here are a few basic checks that are good enough to have a broad overview of the company’s financial strength. However, given that I have not delve into the company-specifics, I recommend you dig deeper yourself into 3308 here.

How much cash does 3308 generate through its operations?

Over the past year, 3308 has reduced its debt from CN¥9.2b to CN¥8.3b – this includes both the current and long-term debt. With this reduction in debt, 3308’s cash and short-term investments stands at CN¥5.6b , ready to deploy into the business. Additionally, 3308 has generated CN¥2.6b in operating cash flow over the same time period, resulting in an operating cash to total debt ratio of 31%, meaning that 3308’s debt is appropriately covered by operating cash. This ratio can also be interpreted as a measure of efficiency as an alternative to return on assets. In 3308’s case, it is able to generate 0.31x cash from its debt capital.

Can 3308 meet its short-term obligations with the cash in hand?

With current liabilities at CN¥8.7b, the company has been able to meet these obligations given the level of current assets of CN¥10.1b, with a current ratio of 1.16x. Usually, for Multiline Retail companies, this is a suitable ratio since there’s a sufficient cash cushion without leaving too much capital idle or in low-earning investments.

Does 3308 face the risk of succumbing to its debt-load?

3308 is a highly-leveraged company with debt exceeding equity by over 100%. This is not unusual for small-caps as debt tends to be a cheaper and faster source of funding for some businesses. We can check to see whether 3308 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 3308’s, case, the ratio of 10.41x 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:

3308’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. This may mean this is an optimal capital structure for the business, given that it is also meeting its short-term commitment. I admit this is a fairly basic analysis for 3308’s financial health. Other important fundamentals need to be considered alongside. You should continue to research Golden Eagle Retail Group to get a more holistic view of the small-cap by looking at: