While small-cap stocks, such as Lisi Group (Holdings) Limited (SEHK:526) with its market cap of HK$7.21B, are popular for their explosive growth, investors should also be aware of their balance sheet to judge whether the company can survive a downturn. Consumer Durables businesses operating in the environment facing headwinds from current disruption, in particular ones that run negative earnings, tend to be high risk. Evaluating financial health as part of your investment thesis is essential. Here are a few basic checks that are good enough to have a broad overview of the company’s financial strength. Nevertheless, given that I have not delve into the company-specifics, I suggest you dig deeper yourself into 526 here.
Does 526 generate enough cash through operations?
526 has built up its total debt levels in the last twelve months, from CN¥1,061.8M to CN¥1,213.3M , which comprises of short- and long-term debt. With this rise in debt, 526’s cash and short-term investments stands at CN¥801.8M for investing into the business. Additionally, 526 has generated cash from operations of CN¥13.3M during the same period of time, leading to an operating cash to total debt ratio of 1.10%, meaning that 526’s current level of operating cash is not high enough to cover debt. This ratio can also be interpreted as a measure of efficiency for loss making businesses since metrics such as return on asset (ROA) requires a positive net income. In 526’s case, it is able to generate 0.01x cash from its debt capital.
Does 526’s liquid assets cover its short-term commitments?
Looking at 526’s most recent CN¥1,602.3M liabilities, the company has been able to meet these obligations given the level of current assets of CN¥1,968.2M, with a current ratio of 1.23x. Generally, for consumer durables 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.
Can 526 service its debt comfortably?
With total debt exceeding equities, 526 is considered a highly levered company. This is not uncommon for a small-cap company given that debt tends to be lower-cost and at times, more accessible. But since 526 is presently unprofitable, sustainability of its current state of operations becomes a concern. Running high debt, while not yet making money, can be risky in unexpected downturns as liquidity may dry up, making it hard to operate.
Next Steps:
Are you a shareholder? 526’s high debt levels is not met with high cash flow coverage. This leaves room for improvement in terms of debt management and operational efficiency. In addition to this, the company may not be able to pay all of its upcoming liabilities from its current short-term assets. Going forward, 526’s financial situation may change. I suggest keeping on top of market expectations for 526’s future growth on our free analysis platform.