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Investors are always looking for growth in small-cap stocks like Modern Dental Group Limited (HKG:3600), with a market cap of HK$1.3b. However, an important fact which most ignore is: how financially healthy is the business? 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. We'll look at some basic checks that can form a snapshot the company’s financial strength. Nevertheless, these checks don't give you a full picture, so I recommend you dig deeper yourself into 3600 here.
3600’s Debt (And Cash Flows)
3600 has built up its total debt levels in the last twelve months, from HK$717m to HK$809m – this includes long-term debt. With this increase in debt, 3600 currently has HK$421m remaining in cash and short-term investments to keep the business going. On top of this, 3600 has produced cash from operations of HK$205m during the same period of time, resulting in an operating cash to total debt ratio of 25%, signalling that 3600’s debt is appropriately covered by operating cash.
Does 3600’s liquid assets cover its short-term commitments?
Looking at 3600’s HK$305m 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 3.14x. The current ratio is calculated by dividing current assets by current liabilities. Having said that, a ratio greater than 3x may be considered by some to be quite high, however this is not necessarily a negative for the company.
Is 3600’s debt level acceptable?
3600 is a relatively highly levered company with a debt-to-equity of 41%. This is somewhat unusual for small-caps companies, since lenders are often hesitant to provide attractive interest rates to less-established businesses. We can test if 3600’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 3600, the ratio of 8.03x suggests that interest is appropriately covered, which means that lenders may be willing to lend out more funding as 3600’s high interest coverage is seen as responsible and safe practice.
Next Steps:
Although 3600’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. This may mean this is an optimal capital structure for the business, given that it is also meeting its short-term commitment. This is only a rough assessment of financial health, and I'm sure 3600 has company-specific issues impacting its capital structure decisions. I suggest you continue to research Modern Dental Group to get a more holistic view of the small-cap by looking at: