China Yongda Automobiles Services Holdings Limited (HKG:3669) is a small-cap stock with a market capitalization of HK$12.5b. While investors primarily focus on the growth potential and competitive landscape of the small-cap companies, they end up ignoring a key aspect, which could be the biggest threat to its existence: its financial health. Why is it important? Companies operating in the Specialty Retail industry facing headwinds from current disruption, even ones that are profitable, tend to be high risk. So, understanding the company’s financial health becomes crucial. I believe these basic checks tell most of the story you need to know. Though, I know these factors are very high-level, so I recommend you dig deeper yourself into 3669 here.

How does 3669’s operating cash flow stack up against its debt?

Over the past year, 3669 has ramped up its debt from CN¥10.8b to CN¥13.2b , which comprises of short- and long-term debt. With this growth in debt, 3669 currently has CN¥2.2b remaining in cash and short-term investments , ready to deploy into the business. Additionally, 3669 has produced cash from operations of CN¥892m during the same period of time, resulting in an operating cash to total debt ratio of 6.8%, signalling that 3669’s operating cash is not sufficient to cover its debt. This ratio can also be interpreted as a measure of efficiency as an alternative to return on assets. In 3669’s case, it is able to generate 0.068x cash from its debt capital.

Can 3669 pay its short-term liabilities?

Looking at 3669’s most recent CN¥16.8b liabilities, the company has been able to meet these obligations given the level of current assets of CN¥18.0b, with a current ratio of 1.07x. Usually, for Specialty Retail companies, this is a suitable ratio since there is a bit of a cash buffer without leaving too much capital in a low-return environment.

Is 3669’s debt level acceptable?

With total debt exceeding equities, 3669 is considered a highly levered company. 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 3669’s case, the ratio of 2.73x suggests that interest is not strongly covered, which means that debtors may be less inclined to loan the company more money, reducing its headroom for growth through debt.