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While small-cap stocks, such as 99 Wuxian Limited (ASX:NNW) with its market cap of AU$110m, are popular for their explosive growth, investors should also be aware of their balance sheet to judge whether the company can survive a downturn. Online Retail businesses operating in the environment facing headwinds from current disruption, in particular ones that run negative earnings, tend to be high risk. So, understanding the company’s financial health becomes crucial. Here are few basic financial health checks you should consider before taking the plunge. Though, since I only look at basic financial figures, I recommend you dig deeper yourself into NNW here.
How does NNW’s operating cash flow stack up against its debt?
Over the past year, NNW has reduced its debt from CN¥198m to CN¥168m , which also accounts for long term debt. With this debt repayment, the current cash and short-term investment levels stands at CN¥136m , ready to deploy into the business. Moreover, NNW has generated CN¥21m in operating cash flow in the last twelve months, resulting in an operating cash to total debt ratio of 12%, signalling that NNW’s debt is not appropriately covered by operating cash. This ratio can also be interpreted as a measure of efficiency for loss making companies as traditional metrics such as return on asset (ROA) requires a positive net income. In NNW’s case, it is able to generate 0.12x cash from its debt capital.
Can NNW pay its short-term liabilities?
At the current liabilities level of CN¥392m, it appears that the company has been able to meet these commitments with a current assets level of CN¥574m, leading to a 1.46x current account ratio. Generally, for Online Retail companies, this is a reasonable ratio since there is a bit of a cash buffer without leaving too much capital in a low-return environment.
Does NNW face the risk of succumbing to its debt-load?
With a debt-to-equity ratio of 55%, NNW can be considered as an above-average leveraged company. This is not unusual for small-caps as debt tends to be a cheaper and faster source of funding for some businesses. Though, since NNW is currently loss-making, sustainability of its current state of operations becomes a concern. Maintaining a high level of debt, while revenues are still below costs, can be dangerous as liquidity tends to dry up in unexpected downturns.
Next Steps:
Although NNW’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 NNW has company-specific issues impacting its capital structure decisions. You should continue to research 99 Wuxian to get a better picture of the small-cap by looking at: