Investors are always looking for growth in small-cap stocks like Xinghua Port Holdings Ltd. (HKG:1990), with a market cap of HK$741m. However, an important fact which most ignore is: how financially healthy is the business? Evaluating financial health as part of your investment thesis is crucial, since poor capital management may bring about bankruptcies, which occur at a higher rate for small-caps. The following basic checks can help you get a picture of the company’s balance sheet strength. Nevertheless, potential investors would need to take a closer look, and I’d encourage you to dig deeper yourself into 1990 here.
1990’s Debt (And Cash Flows)
1990 has sustained its debt level by about CN¥629m over the last 12 months – this includes long-term debt. At this stable level of debt, 1990’s cash and short-term investments stands at CN¥153m , ready to be used for running the business. Additionally, 1990 has produced CN¥87m in operating cash flow during the same period of time, leading to an operating cash to total debt ratio of 14%, meaning that 1990’s operating cash is less than its debt.
Does 1990’s liquid assets cover its short-term commitments?
With current liabilities at CN¥244m, it seems that the business has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 1.04x. The current ratio is the number you get when you divide current assets by current liabilities. Usually, for Infrastructure companies, this is a suitable ratio since there is a bit of a cash buffer without leaving too much capital in a low-return environment.
Does 1990 face the risk of succumbing to its debt-load?
With a debt-to-equity ratio of 70%, 1990 can be considered as an above-average leveraged company. This is a bit unusual for a small-cap stock, since they generally have a harder time borrowing than large more established companies. No matter how high the company’s debt, if it can easily cover the interest payments, it’s considered to be efficient with its use of excess leverage. A company generating earnings before interest and tax (EBIT) at least three times its net interest payments is considered financially sound. In 1990’s case, the ratio of 4.86x suggests that interest is appropriately covered, which means that debtors may be willing to loan the company more money, giving 1990 ample headroom to grow its debt facilities.
Next Steps:
Although 1990’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. Since there is also no concerns around 1990’s liquidity needs, this may be its optimal capital structure for the time being. This is only a rough assessment of financial health, and I’m sure 1990 has company-specific issues impacting its capital structure decisions. I recommend you continue to research Xinghua Port Holdings to get a more holistic view of the small-cap by looking at: