While small-cap stocks, such as Four Seas Mercantile Holdings Limited (SEHK:374) with its market cap of HK$1.29B, 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. I believe these basic checks tell most of the story you need to know. Though, since I only look at basic financial figures, I’d encourage you to dig deeper yourself into 374 here.
Does 374 generate an acceptable amount of cash through operations?
374 has shrunken its total debt levels in the last twelve months, from HK$1,109.5M to HK$1,012.6M , which is made up of current and long term debt. With this debt repayment, 374’s cash and short-term investments stands at HK$962.5M for investing into the business. On top of this, 374 has generated cash from operations of HK$76.2M during the same period of time, resulting in an operating cash to total debt ratio of 0.08x, signalling that 374’s current level of operating cash is not high enough to cover debt. This ratio can also be a sign of operational efficiency as an alternative to return on assets. In 374’s case, it is able to generate 0.08x cash from its debt capital.
Can 374 pay its short-term liabilities?
At the current liabilities level of HK$1,315.5M liabilities, it seems that the business has been able to meet these commitments with a current assets level of HK$1,907.4M, leading to a 1.45x current account ratio. For food companies, this ratio is within a sensible range since there is a bit of a cash buffer without leaving too much capital in a low-return environment.
Does 374 face the risk of succumbing to its debt-load?
374 is a relatively highly levered company with a debt-to-equity of 47.97%. This is not uncommon for a small-cap company given that debt tends to be lower-cost and at times, more accessible. We can test if 374’s debt levels are sustainable by measuring interest payments against earnings of a company. Ideally, earnings before interest and tax (EBIT) should cover net interest by at least three times. For 374, the ratio of 6.15x suggests that interest is appropriately covered, which means that lenders may be less hesitant to lend out more funding as 374’s high interest coverage is seen as responsible and safe practice.
Next Steps:
Are you a shareholder? 374’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. However, the company exhibits an ability to meet its near term obligations should an adverse event occur. Given that its financial position may change. I recommend keeping abreast of market expectations for 374’s future growth on our free analysis platform.