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Investors are always looking for growth in small-cap stocks like Zhong Ao Home Group Limited (HKG:1538), with a market cap of HK$608m. However, an important fact which most ignore is: how financially healthy is the business? Evaluating financial health as part of your investment thesis is essential, since poor capital management may bring about 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. However, given that I have not delve into the company-specifics, I suggest you dig deeper yourself into 1538 here.
How much cash does 1538 generate through its operations?
1538’s debt levels have fallen from CN¥124m to CN¥100m over the last 12 months – this includes both the current and long-term debt. With this reduction in debt, 1538’s cash and short-term investments stands at CN¥347m , ready to deploy into the business. On top of this, 1538 has generated cash from operations of CN¥72m over the same time period, resulting in an operating cash to total debt ratio of 72%, signalling that 1538’s debt is appropriately covered by operating cash. This ratio can also be a sign of operational efficiency as an alternative to return on assets. In 1538’s case, it is able to generate 0.72x cash from its debt capital.
Does 1538’s liquid assets cover its short-term commitments?
At the current liabilities level of CN¥591m liabilities, the company has been able to meet these commitments with a current assets level of CN¥758m, leading to a 1.28x current account ratio. For Real Estate companies, this ratio is within a sensible range since there’s a sufficient cash cushion without leaving too much capital idle or in low-earning investments.
Does 1538 face the risk of succumbing to its debt-load?
1538’s level of debt is appropriate relative to its total equity, at 18%. This range is considered safe as 1538 is not taking on too much debt obligation, which can be restrictive and risky for equity-holders. We can test if 1538’s debt levels are sustainable by measuring interest payments against earnings of a company. Ideally, earnings before interest and tax (EBIT) should cover net interest by at least three times. For 1538, the ratio of 488x suggests that interest is comfortably covered, which means that lenders may be inclined to lend more money to the company, as it is seen as safe in terms of payback.
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1538 has demonstrated its ability to generate sufficient levels of cash flow, while its debt hovers at a safe level. Furthermore, the company exhibits an ability to meet its near term obligations should an adverse event occur. I admit this is a fairly basic analysis for 1538’s financial health. Other important fundamentals need to be considered alongside. I recommend you continue to research Zhong Ao Home Group to get a more holistic view of the stock by looking at: