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Investors are always looking for growth in small-cap stocks like SOHO China Limited (HKG:410), with a market cap of HK$16b. However, an important fact which most ignore is: how financially healthy is the business? Assessing first and foremost the financial health is essential, as mismanagement of capital can lead to bankruptcies, which occur at a higher rate for small-caps. Here are a few basic checks that are good enough to have a broad overview of the company’s financial strength. Though, since I only look at basic financial figures, I recommend you dig deeper yourself into 410 here.
How much cash does 410 generate through its operations?
410’s debt level has been constant at around CN¥19b over the previous year including long-term debt. At this constant level of debt, the current cash and short-term investment levels stands at CN¥3.3b for investing into the business. Moving onto cash from operations, its trivial cash flows from operations make the cash-to-debt ratio less useful to us, though these low levels of cash means that operational efficiency is worth a look. As the purpose of this article is a high-level overview, I won’t be looking at this today, but you can take a look at some of 410’s operating efficiency ratios such as ROA here.
Does 410’s liquid assets cover its short-term commitments?
At the current liabilities level of CN¥9.5b, it seems that the business may not be able to easily meet these obligations given the level of current assets of CN¥7.2b, with a current ratio of 0.75x.
Can 410 service its debt comfortably?
With debt reaching 54% of equity, 410 may be thought of as relatively highly levered. This is not uncommon for a small-cap company given that debt tends to be lower-cost and at times, more accessible. We can check to see whether 410 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 410’s, case, the ratio of 2.3x suggests that interest is not strongly covered, which means that lenders may refuse to lend the company more money, as it is seen as too risky in terms of default.
Next Steps:
Although 410’s debt level is towards the higher end of the spectrum, its cash flow coverage seems adequate to meet debt obligations which means its debt is being efficiently utilised. However, its lack of liquidity raises questions over current asset management practices for the small-cap. Keep in mind I haven’t considered other factors such as how 410 has been performing in the past. You should continue to research SOHO China to get a more holistic view of the stock by looking at: