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IT Limited (HKG:999) is a small-cap stock with a market capitalization of HK$4.3b. 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? Specialty Retail businesses operating in the environment facing headwinds from current disruption, even ones that are profitable, are inclined towards being higher risk. So, understanding the company’s financial health becomes vital. Here are a few basic checks that are good enough to have a broad overview of the company’s financial strength. Nevertheless, given that I have not delve into the company-specifics, I recommend you dig deeper yourself into 999 here.
How does 999’s operating cash flow stack up against its debt?
999 has sustained its debt level by about HK$1.4b over the last 12 months – this includes both the current and long-term debt. At this current level of debt, 999’s cash and short-term investments stands at HK$2.3b for investing into the business. Moreover, 999 has produced HK$993m in operating cash flow during the same period of time, resulting in an operating cash to total debt ratio of 71%, meaning that 999’s operating cash is sufficient to cover its debt. This ratio can also be a sign of operational efficiency as an alternative to return on assets. In 999’s case, it is able to generate 0.71x cash from its debt capital.
Does 999’s liquid assets cover its short-term commitments?
At the current liabilities level of HK$2.6b liabilities, the company has been able to meet these obligations given the level of current assets of HK$4.5b, with a current ratio of 1.73x. Generally, for Specialty Retail companies, this is a reasonable ratio since there is a bit of a cash buffer without leaving too much capital in a low-return environment.
Can 999 service its debt comfortably?
With a debt-to-equity ratio of 40%, 999’s debt level may be seen as prudent. 999 is not taking on too much debt commitment, which can be restrictive and risky for equity-holders. We can check to see whether 999 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 999’s, case, the ratio of 15.06x suggests that interest is comfortably 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.