Lee & Man Chemical Company Limited (HKG:746) is a small-cap stock with a market capitalization of HK$3.8b. 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? Assessing first and foremost the financial health is vital, since poor capital management may bring about bankruptcies, which occur at a higher rate for small-caps. I believe these basic checks tell most of the story you need to know. However, given that I have not delve into the company-specifics, I suggest you dig deeper yourself into 746 here.

How much cash does 746 generate through its operations?

Over the past year, 746 has reduced its debt from HK$2.2b to HK$2.1b , which is made up of current and long term debt. With this debt repayment, 746’s cash and short-term investments stands at HK$333m , ready to deploy into the business. Additionally, 746 has produced cash from operations of HK$1.2b during the same period of time, leading to an operating cash to total debt ratio of 60%, signalling that 746’s current level of operating cash is high enough to cover debt. This ratio can also be a sign of operational efficiency as an alternative to return on assets. In 746’s case, it is able to generate 0.6x cash from its debt capital.

Does 746’s liquid assets cover its short-term commitments?

Looking at 746’s most recent HK$1.3b liabilities, it appears that the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 1.32x. Usually, for Chemicals companies, this is a suitable ratio as there’s enough of a cash buffer without holding too much capital in low return investments.

Is 746’s debt level acceptable?

With a debt-to-equity ratio of 59%, 746 can be considered as an above-average leveraged company. This is not unusual for small-caps as debt tends to be a cheaper and faster source of funding for some businesses. We can test if 746’s debt levels are sustainable by measuring interest payments against earnings of a company. Ideally, earnings before interest and tax (EBIT) should cover net interest by at least three times. For 746, the ratio of 14.91x suggests that interest is comfortably covered, which means that lenders may be less hesitant to lend out more funding as 746’s high interest coverage is seen as responsible and safe practice.

Next Steps:

746’s high cash coverage means that, although its debt levels are high, the company is able to utilise its borrowings efficiently in order to generate cash flow. Since there is also no concerns around 746’s liquidity needs, this may be its optimal capital structure for the time being. I admit this is a fairly basic analysis for 746’s financial health. Other important fundamentals need to be considered alongside. I recommend you continue to research Lee & Man Chemical to get a more holistic view of the small-cap by looking at:

1. Future Outlook: What are well-informed industry analysts predicting for 746’s future growth? Take a look at our free research report of analyst consensus for 746’s outlook.

2. Historical Performance: What has 746’s returns been like over the past? Go into more detail in the past track record analysis and take a look at the free visual representations of our analysis for more clarity.

3. Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.