West China Cement Limited (HKG:2233) is a small-cap stock with a market capitalization of HK$7.23b. 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? So, understanding the company’s financial health becomes essential, since poor capital management may bring about bankruptcies, which occur at a higher rate for small-caps. I believe these basic checks tell most of the story you need to know. Though, I know these factors are very high-level, so I’d encourage you to dig deeper yourself into 2233 here.

How does 2233’s operating cash flow stack up against its debt?

2233 has shrunken its total debt levels in the last twelve months, from HK$4.01b to HK$3.74b – this includes both the current and long-term debt. With this debt payback, the current cash and short-term investment levels stands at HK$1.38b for investing into the business. Moreover, 2233 has generated HK$1.77b in operating cash flow in the last twelve months, leading to an operating cash to total debt ratio of 47.32%, meaning that 2233’s current level of operating cash is high enough to cover debt. This ratio can also be interpreted as a measure of efficiency as an alternative to return on assets. In 2233’s case, it is able to generate 0.47x cash from its debt capital.

Does 2233’s liquid assets cover its short-term commitments?

Looking at 2233’s most recent HK$2.14b liabilities, it seems that the business has been able to meet these obligations given the level of current assets of HK$3.00b, with a current ratio of 1.4x. Generally, for Basic Materials companies, this is a reasonable ratio as there’s enough of a cash buffer without holding too capital in low return investments.

Does 2233 face the risk of succumbing to its debt-load?

With debt reaching 56.42% of equity, 2233 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 2233 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 2233’s, case, the ratio of 3.86x suggests that interest is appropriately covered, which means that lenders may be less hesitant to lend out more funding as 2233’s high interest coverage is seen as responsible and safe practice.

Next Steps:

2233’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 2233 has company-specific issues impacting its capital structure decisions. I recommend you continue to research West China Cement to get a more holistic view of the small-cap by looking at:

1. Future Outlook: What are well-informed industry analysts predicting for 2233’s future growth? Take a look at our free research report of analyst consensus for 2233’s outlook.

2. Valuation: What is 2233 worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether 2233 is currently mispriced by the market.

3. Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.

To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned.