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While small-cap stocks, such as Shenglong Splendecor International Limited (HKG:8481) with its market cap of HK$195m, are popular for their explosive growth, investors should also be aware of their balance sheet to judge whether the company can survive a downturn. 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. I believe these basic checks tell most of the story you need to know. Though, I know these factors are very high-level, so I suggest you dig deeper yourself into 8481 here.
Does 8481 produce enough cash relative to debt?
Over the past year, 8481 has reduced its debt from CN¥109m to CN¥96m , which comprises of short- and long-term debt. With this debt payback, 8481’s cash and short-term investments stands at CN¥9m , ready to deploy into the business. Moving onto cash from operations, its small level of operating cash flow means calculating cash-to-debt wouldn’t be too useful, though these low levels of cash means that operational efficiency is worth a look. For this article’s sake, I won’t be looking at this today, but you can take a look at some of 8481’s operating efficiency ratios such as ROA here.
Does 8481’s liquid assets cover its short-term commitments?
At the current liabilities level of CN¥227m liabilities, the company may not have an easy time meeting these commitments with a current assets level of CN¥191m, leading to a current ratio of 0.84x.
Can 8481 service its debt comfortably?
8481 is a relatively highly levered company with a debt-to-equity of 59%. This is not uncommon for a small-cap company given that debt tends to be lower-cost and at times, more accessible. We can check to see whether 8481 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 8481’s, case, the ratio of 7.01x suggests that interest is appropriately 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:
8481’s debt and cash flow levels indicate room for improvement. Its cash flow coverage of less than a quarter of debt means that operating efficiency could be an issue. Furthermore, its lack of liquidity raises questions over current asset management practices for the small-cap. This is only a rough assessment of financial health, and I’m sure 8481 has company-specific issues impacting its capital structure decisions. I suggest you continue to research Shenglong Splendecor International to get a better picture of the stock by looking at: