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Investors are always looking for growth in small-cap stocks like Xinming China Holdings Limited (HKG:2699), with a market cap of HK$2.1b. However, an important fact which most ignore is: how financially healthy is the business? Assessing first and foremost the financial health 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. However, this is not a comprehensive overview, so I suggest you dig deeper yourself into 2699 here.
2699’s Debt (And Cash Flows)
Over the past year, 2699 has ramped up its debt from CN¥2.1b to CN¥2.3b , which includes long-term debt. With this increase in debt, 2699 currently has CN¥144m remaining in cash and short-term investments to keep the business going. Additionally, 2699 has produced CN¥53m in operating cash flow in the last twelve months, leading to an operating cash to total debt ratio of 2.4%, indicating that 2699’s debt is not covered by operating cash.
Can 2699 meet its short-term obligations with the cash in hand?
At the current liabilities level of CN¥3.2b, it seems that the business has been able to meet these obligations given the level of current assets of CN¥3.5b, with a current ratio of 1.1x. The current ratio is the number you get when you divide current assets by current liabilities. Usually, for Real Estate companies, this is a suitable ratio as there's enough of a cash buffer without holding too much capital in low return investments.
Is 2699’s debt level acceptable?
With total debt exceeding equity, 2699 is considered a highly levered company. This is somewhat unusual for small-caps companies, since lenders are often hesitant to provide attractive interest rates to less-established businesses. We can check to see whether 2699 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 2699's, case, the ratio of 18.34x suggests that interest is comfortably covered, which means that lenders may be willing to lend out more funding as 2699’s high interest coverage is seen as responsible and safe practice.
Next Steps:
Although 2699’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. 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 2699 has company-specific issues impacting its capital structure decisions. I suggest you continue to research Xinming China Holdings to get a more holistic view of the small-cap by looking at: