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Investors are always looking for growth in small-cap stocks like KSH Holdings Limited (SGX:ER0), with a market cap of S$302m. However, an important fact which most ignore is: how financially healthy is the business? So, understanding the company’s financial health becomes crucial, as mismanagement of capital can lead to bankruptcies, which occur at a higher rate for small-caps. Here are few basic financial health checks you should consider before taking the plunge. However, since I only look at basic financial figures, I recommend you dig deeper yourself into ER0 here.
How does ER0’s operating cash flow stack up against its debt?
Over the past year, ER0 has ramped up its debt from S$85m to S$164m – this includes long-term debt. With this increase in debt, the current cash and short-term investment levels stands at S$79m , ready to deploy into the business. Moreover, ER0 has produced cash from operations of S$8.5m over the same time period, resulting in an operating cash to total debt ratio of 5.2%, meaning that ER0’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 ER0’s case, it is able to generate 0.052x cash from its debt capital.
Can ER0 pay its short-term liabilities?
Looking at ER0’s S$163m in current liabilities, it seems that the business has been able to meet these commitments with a current assets level of S$180m, leading to a 1.1x current account ratio. Usually, for Construction companies, this is a suitable ratio as there’s enough of a cash buffer without holding too much capital in low return investments.
Is ER0’s debt level acceptable?
ER0 is a relatively highly levered company with a debt-to-equity of 46%. This is not uncommon for a small-cap company given that debt tends to be lower-cost and at times, more accessible. We can test if ER0’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 ER0, the ratio of 8x suggests that interest is appropriately covered, which means that lenders may be inclined to lend more money to the company, as it is seen as safe in terms of payback.
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ER0’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 ER0’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 ER0 has company-specific issues impacting its capital structure decisions. You should continue to research KSH Holdings to get a better picture of the small-cap by looking at: