Lingbao Gold Group Company Ltd (SEHK:3330) is a small-cap stock with a market capitalization of HK$1.01B. 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, as mismanagement of capital can lead to 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. Though, I know these factors are very high-level, so I suggest you dig deeper yourself into 3330 here.

Does 3330 generate enough cash through operations?

Over the past year, 3330 has maintained its debt levels at around CN¥5,097.4M comprising of short- and long-term debt. At this constant level of debt, the current cash and short-term investment levels stands at CN¥1,164.6M , ready to deploy into the business. Moreover, 3330 has generated CN¥861.1M in operating cash flow during the same period of time, resulting in an operating cash to total debt ratio of 16.89%, signalling that 3330’s debt is not appropriately covered by operating cash. This ratio can also be a sign of operational efficiency as an alternative to return on assets. In 3330’s case, it is able to generate 0.17x cash from its debt capital.

Can 3330 pay its short-term liabilities?

Looking at 3330’s most recent CN¥4,462.5M liabilities, it seems that the business is not able to meet these obligations given the level of current assets of CN¥3,573.5M, with a current ratio of 0.8x below the prudent level of 3x.

Is 3330’s level of debt at an acceptable level?

Since total debt levels have outpaced equities, 3330 is a highly leveraged company. This is not unusual for small-caps as debt tends to be a cheaper and faster source of funding for some businesses. 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 after interest and tax at least three times its net interest payments is considered financially sound. In 3330’s case, the ratio of 1.48x suggests that interest is not strongly covered, which means that debtors may be less inclined to loan the company more money, reducing its headroom for growth through debt.

Next Steps:

Are you a shareholder? With a high level of debt on its balance sheet, 3330 could still be in a financially strong position if its cash flow also stacked up. However, this isn’t the case, and there’s room for 3330 to increase its operational efficiency. In addition to this, the company may not be able to pay all of its upcoming liabilities from its current short-term assets. In the future, its financial position may change. I suggest keeping on top of market expectations for 3330’s future growth on our free analysis platform.

Are you a potential investor? 3330’s high debt levels on top of low cash coverage of debt as well as low liquidity coverage of short-term expenses may not build the strongest investment case. However, keep in mind that this is a point-in-time analysis, and today’s performance may not be representative of 3330’s track record. I encourage you to continue your research by taking a look at 3330’s past performance analysis on our free platform in order to determine for yourself whether its debt position is justified.

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.