China Aoyuan Property Group Limited (SEHK:3883) is a small-cap stock with a market capitalization of HK$11.03B. 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? Evaluating financial health as part of your investment thesis is crucial, as mismanagement of capital can lead to 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, since I only look at basic financial figures, I recommend you dig deeper yourself into 3883 here.
Does 3883 generate enough cash through operations?
3883 has built up its total debt levels in the last twelve months, from CN¥16,402.4M to CN¥19,730.9M , which comprises of short- and long-term debt. With this increase in debt, the current cash and short-term investment levels stands at CN¥10,470.9M for investing into the business. Additionally, 3883 has produced CN¥5,944.9M in operating cash flow over the same time period, leading to an operating cash to total debt ratio of 0.3x, indicating that 3883’s debt is appropriately covered by operating cash. This ratio can also be interpreted as a measure of efficiency as an alternative to return on assets. In 3883’s case, it is able to generate 0.3x cash from its debt capital.
Does 3883’s liquid assets cover its short-term commitments?
With current liabilities at CN¥36,142.6M liabilities, the company has been able to meet these commitments with a current assets level of CN¥59,829.6M, leading to a 1.66x current account ratio. Usually, for real estate companies, this is a suitable ratio as there’s enough of a cash buffer without holding too capital in low return investments.
Is 3883’s level of debt at an acceptable level?
With total debt exceeding equities, 3883 is considered a highly levered company. This is not unusual for small-caps as debt tends to be a cheaper and faster source of funding for some businesses. We can test if 3883’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 3883, the ratio of 46.63x suggests that interest is excessively 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.
Next Steps:
Are you a shareholder? At its current level of cash flow coverage, 3883 has room for improvement to better cushion for events which may require debt repayment. Though, its high liquidity means the company should continue to operate smoothly in the case of adverse events. Given that its financial position may change. You should always be keeping abreast of market expectations for 3883’s future growth on our free analysis platform.