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While small-cap stocks, such as Royal Deluxe Holdings Limited (HKG:3789) with its market cap of HK$348m, are popular for their explosive growth, investors should also be aware of their balance sheet to judge whether the company can survive a downturn. So, understanding the company’s financial health becomes crucial, since poor capital management may bring about bankruptcies, which occur at a higher rate for small-caps. Here are few basic financial health checks you should consider before taking the plunge. Though, I know these factors are very high-level, so I suggest you dig deeper yourself into 3789 here.
How does 3789’s operating cash flow stack up against its debt?
Over the past year, 3789 has ramped up its debt from HK$30m to HK$56m made up of predominantly near term debt. With this rise in debt, 3789 currently has HK$30m remaining in cash and short-term investments for investing into the business. Moving onto cash from operations, its operating cash flow is not yet significant enough to calculate a meaningful cash-to-debt ratio, indicating that operational efficiency is something we’d need to take a look at. For this article’s sake, I won’t be looking at this today, but you can examine some of 3789’s operating efficiency ratios such as ROA here.
Can 3789 meet its short-term obligations with the cash in hand?
With current liabilities at HK$143m, the company has been able to meet these obligations given the level of current assets of HK$259m, with a current ratio of 1.81x. Generally, for Construction companies, this is a reasonable ratio as there’s enough of a cash buffer without holding too much capital in low return investments.
Does 3789 face the risk of succumbing to its debt-load?
3789’s level of debt is appropriate relative to its total equity, at 29%. This range is considered safe as 3789 is not taking on too much debt obligation, which may be constraining for future growth. We can check to see whether 3789 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 3789’s, case, the ratio of 15.37x suggests that interest is comfortably covered, which means that lenders may be less hesitant to lend out more funding as 3789’s high interest coverage is seen as responsible and safe practice.
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3789’s debt level is appropriate for a company its size, and it is also able to generate sufficient cash flow coverage, meaning it has been able to put its debt in good use. Furthermore, the company exhibits an ability to meet its near term obligations should an adverse event occur. This is only a rough assessment of financial health, and I’m sure 3789 has company-specific issues impacting its capital structure decisions. I suggest you continue to research Royal Deluxe Holdings to get a more holistic view of the stock by looking at: