While small-cap stocks, such as China Everbright Water Limited (SGX:U9E) with its market cap of SGD1.23B, 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 essential, as mismanagement of capital can lead to bankruptcies, which occur at a higher rate for small-caps. I believe these basic checks tell most of the story you need to know. Though, this commentary is still very high-level, so I recommend you dig deeper yourself into U9E here.

Does U9E generate an acceptable amount of cash through operations?

Over the past year, U9E has maintained its debt levels at around HK$5,116.0M comprising of short- and long-term debt. At this stable level of debt, the current cash and short-term investment levels stands at HK$1,902.7M , ready to deploy into the business. Moreover, U9E has produced HK$20.2M in operating cash flow during the same period of time, leading to an operating cash to total debt ratio of 0.0039%, indicating that U9E’s debt is not appropriately covered by operating cash. This ratio can also be interpreted as a measure of efficiency as an alternative to return on assets. In U9E’s case, it is able to generate 0x cash from its debt capital.

Can U9E pay its short-term liabilities?

Looking at U9E’s most recent HK$2,471.7M liabilities, the company has been able to meet these obligations given the level of current assets of HK$3,297.4M, with a current ratio of 1.33x. Generally, for Water Utilities 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.

Does U9E face the risk of succumbing to its debt-load?

U9E is a relatively highly levered company with a debt-to-equity of 78.37%. This is not unusual for small-caps as debt tends to be a cheaper and faster source of funding for some businesses. 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 U9E’s case, the ratio of 4.39x suggests that interest is appropriately covered, which means that debtors may be willing to loan the company more money, giving U9E ample headroom to grow its debt facilities.

Next Steps:

U9E’s debt and cash flow levels indicate room for improvement. Its cash flow coverage of less than a quarter of debt means that operating efficiency could be an issue. Though, the company will be able to pay all of its upcoming liabilities from its current short-term assets. I admit this is a fairly basic analysis for U9E’s financial health. Other important fundamentals need to be considered alongside. You should continue to research China Everbright Water to get a more holistic view of the stock by looking at: