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While small-cap stocks, such as Hebei Yichen Industrial Group Corporation Limited (HKG:1596) with its market cap of HK$2.8b, are popular for their explosive growth, investors should also be aware of their balance sheet to judge whether the company can survive a downturn. Evaluating financial health as part of your investment thesis is crucial, 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. However, given that I have not delve into the company-specifics, I recommend you dig deeper yourself into 1596 here.
How does 1596’s operating cash flow stack up against its debt?
Over the past year, 1596 has maintained its debt levels at around CN¥303m which accounts for long term debt. At this stable level of debt, the current cash and short-term investment levels stands at CN¥319m for investing into the business. Additionally, 1596 has produced CN¥59m in operating cash flow during the same period of time, resulting in an operating cash to total debt ratio of 19%, signalling that 1596’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 1596’s case, it is able to generate 0.19x cash from its debt capital.
Can 1596 meet its short-term obligations with the cash in hand?
At the current liabilities level of CN¥839m, the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 2.56x. Generally, for Machinery companies, this is a reasonable ratio as there’s enough of a cash buffer without holding too much capital in low return investments.
Can 1596 service its debt comfortably?
With debt at 17% of equity, 1596 may be thought of as appropriately levered. 1596 is not taking on too much debt commitment, which can be restrictive and risky for equity-holders. We can check to see whether 1596 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 1596’s, case, the ratio of 14.75x 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.