While small-cap stocks, such as China Automation Group Limited (HKG:569) with its market cap of HK$1.1b, are popular for their explosive growth, investors should also be aware of their balance sheet to judge whether the company can survive a downturn. Given that 569 is not presently profitable, it’s crucial to understand the current state of its operations and pathway to profitability. Here are a few basic checks that are good enough to have a broad overview of the company’s financial strength. Nevertheless, since I only look at basic financial figures, I’d encourage you to dig deeper yourself into 569 here.
How much cash does 569 generate through its operations?
569 has built up its total debt levels in the last twelve months, from CN¥760m to CN¥1.4b , which is made up of current and long term debt. With this growth in debt, 569’s cash and short-term investments stands at CN¥394m for investing into the business. Additionally, 569 has produced cash from operations of CN¥172m during the same period of time, resulting in an operating cash to total debt ratio of 12%, signalling that 569’s debt is not appropriately covered by operating cash. This ratio can also be a sign of operational efficiency for loss making businesses as traditional metrics such as return on asset (ROA) requires positive earnings. In 569’s case, it is able to generate 0.12x cash from its debt capital.
Does 569’s liquid assets cover its short-term commitments?
At the current liabilities level of CN¥1.4b liabilities, it appears that the company has been able to meet these commitments with a current assets level of CN¥2.2b, leading to a 1.55x current account ratio. Generally, for Machinery companies, this is a reasonable ratio since there’s a sufficient cash cushion without leaving too much capital idle or in low-earning investments.
Can 569 service its debt comfortably?
With total debt exceeding equities, 569 is considered a highly levered company. This is not uncommon for a small-cap company given that debt tends to be lower-cost and at times, more accessible. Though, since 569 is presently unprofitable, sustainability of its current state of operations becomes a concern. Running high debt, while not yet making money, can be risky in unexpected downturns as liquidity may dry up, making it hard to operate.
Next Steps:
569’s cash flow coverage indicates it could improve its operating efficiency in order to meet demand for debt repayments should unforeseen events arise. However, the company exhibits an ability to meet its near term obligations should an adverse event occur. Keep in mind I haven’t considered other factors such as how 569 has been performing in the past. I suggest you continue to research China Automation Group to get a more holistic view of the stock by looking at: