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Ever Reach Group (Holdings) Company Limited (HKG:3616) is a small-cap stock with a market capitalization of HK$1.2b. 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? Assessing first and foremost the financial health is essential, since poor capital management may bring about bankruptcies, which occur at a higher rate for small-caps. The following basic checks can help you get a picture of the company's balance sheet strength. Nevertheless, these checks don't give you a full picture, so I’d encourage you to dig deeper yourself into 3616 here.
Does 3616 Produce Much Cash Relative To Its Debt?
3616 has shrunk its total debt levels in the last twelve months, from CN¥1.9b to CN¥1.1b – this includes long-term debt. With this debt repayment, the current cash and short-term investment levels stands at CN¥420m to keep the business going. Additionally, 3616 has generated cash from operations of CN¥569m during the same period of time, leading to an operating cash to total debt ratio of 53%, meaning that 3616’s current level of operating cash is high enough to cover debt.
Can 3616 meet its short-term obligations with the cash in hand?
Looking at 3616’s CN¥3.6b in current liabilities, the company has been able to meet these obligations given the level of current assets of CN¥5.0b, with a current ratio of 1.4x. The current ratio is calculated by dividing current assets by current liabilities. Usually, for Real Estate companies, this is a suitable ratio as there's enough of a cash buffer without holding too much capital in low return investments.
Is 3616’s debt level acceptable?
3616 is a highly-leveraged company with debt exceeding equity by over 100%. This is somewhat unusual for small-caps companies, since lenders are often hesitant to provide attractive interest rates to less-established businesses. We can check to see whether 3616 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 3616's, case, the ratio of 10.65x suggests that interest is comfortably 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.
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3616’s high cash coverage means that, although its debt levels are high, the company is able to utilise its borrowings efficiently in order to generate cash flow. Since there is also no concerns around 3616's liquidity needs, this may be its optimal capital structure for the time being. This is only a rough assessment of financial health, and I'm sure 3616 has company-specific issues impacting its capital structure decisions. You should continue to research Ever Reach Group (Holdings) to get a better picture of the small-cap by looking at: