Investors are always looking for growth in small-cap stocks like SOCAM Development Limited (HKG:983), with a market cap of HK$723m. However, an important fact which most ignore is: how financially healthy is the business? Since 983 is loss-making right now, it’s crucial to assess the current state of its operations and pathway to profitability. Here are few basic financial health checks you should consider before taking the plunge. Nevertheless, this commentary is still very high-level, so I’d encourage you to dig deeper yourself into 983 here.

How does 983’s operating cash flow stack up against its debt?

Over the past year, 983 has ramped up its debt from HK$3.1b to HK$3.6b , which includes long-term debt. With this increase in debt, the current cash and short-term investment levels stands at HK$1.2b for investing into the business. On top of this, 983 has generated HK$465m in operating cash flow during the same period of time, leading to an operating cash to total debt ratio of 13%, signalling that 983’s operating cash is not sufficient to cover its debt. This ratio can also be a sign of operational efficiency for unprofitable companies since metrics such as return on asset (ROA) requires a positive net income. In 983’s case, it is able to generate 0.13x cash from its debt capital.

Can 983 meet its short-term obligations with the cash in hand?

With current liabilities at HK$4.3b, the company has been able to meet these obligations given the level of current assets of HK$6.5b, with a current ratio of 1.51x. Usually, for Construction companies, this is a suitable ratio since there’s a sufficient cash cushion without leaving too much capital idle or in low-earning investments.

Is 983’s debt level acceptable?

983 is a highly-leveraged company with debt exceeding equity by over 100%. This is not unusual for small-caps as debt tends to be a cheaper and faster source of funding for some businesses. But since 983 is currently loss-making, sustainability of its current state of operations becomes a concern. Maintaining a high level of debt, while revenues are still below costs, can be dangerous as liquidity tends to dry up in unexpected downturns.

Next Steps:

983’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. 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 983 has company-specific issues impacting its capital structure decisions. I suggest you continue to research SOCAM Development to get a better picture of the small-cap by looking at: