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Investors are always looking for growth in small-cap stocks like China High Speed Transmission Equipment Group Co., Ltd. (HKG:658), with a market cap of HK$12b. However, an important fact which most ignore is: how financially healthy is the business? So, understanding the company’s financial health becomes 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. Nevertheless, this commentary is still very high-level, so I recommend you dig deeper yourself into 658 here.
How much cash does 658 generate through its operations?
Over the past year, 658 has ramped up its debt from CN¥6.8b to CN¥8.6b , which includes long-term debt. With this growth in debt, 658 currently has CN¥7.0b remaining in cash and short-term investments , ready to deploy into the business. Additionally, 658 has produced cash from operations of CN¥1.9b over the same time period, resulting in an operating cash to total debt ratio of 22%, signalling that 658’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 658’s case, it is able to generate 0.22x cash from its debt capital.
Can 658 pay its short-term liabilities?
Looking at 658’s CN¥15b in current liabilities, it seems that the business has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 1.26x. For Electrical companies, this ratio is within a sensible range as there’s enough of a cash buffer without holding too much capital in low return investments.
Can 658 service its debt comfortably?
With debt reaching 79% of equity, 658 may be thought of as relatively highly levered. This is not uncommon for a small-cap company given that debt tends to be lower-cost and at times, more accessible. We can check to see whether 658 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 658’s, case, the ratio of 1.14x suggests that interest is not strongly covered, which means that lenders may refuse to lend the company more money, as it is seen as too risky in terms of default.
Next Steps:
Although 658’s debt level is towards the higher end of the spectrum, its cash flow coverage seems adequate to meet obligations which means its debt is being efficiently utilised. Since there is also no concerns around 658’s liquidity needs, this may be its optimal capital structure for the time being. This is only a rough assessment of financial health, and I’m sure 658 has company-specific issues impacting its capital structure decisions. You should continue to research China High Speed Transmission Equipment Group to get a better picture of the small-cap by looking at: