While small-cap stocks, such as Guangdong Tannery Limited (SEHK:1058) with its market cap of HK$430.42M, are popular for their explosive growth, investors should also be aware of their balance sheet to judge whether the company can survive a downturn. Given that 1058 is not presently profitable, it’s crucial to assess the current state of its operations and pathway to profitability. Here are few basic financial health checks you should consider before taking the plunge. Though, given that I have not delve into the company-specifics, I recommend you dig deeper yourself into 1058 here.
How does 1058’s operating cash flow stack up against its debt?
Over the past year, 1058 has ramped up its debt from HK$192.6M to HK$225.9M – this includes both the current and long-term debt. With this increase in debt, the current cash and short-term investment levels stands at HK$48.3M for investing into the business. Additionally, 1058 has produced cash from operations of HK$17.9M during the same period of time, resulting in an operating cash to total debt ratio of 7.93%, indicating that 1058’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 unprofitable companies as traditional metrics such as return on asset (ROA) requires a positive net income. In 1058’s case, it is able to generate 0.08x cash from its debt capital.
Does 1058’s liquid assets cover its short-term commitments?
Looking at 1058’s most recent HK$188.1M liabilities, it appears that the company has been able to meet these obligations given the level of current assets of HK$456.5M, with a current ratio of 2.43x. Usually, for luxury companies, this is a suitable ratio since there is a bit of a cash buffer without leaving too much capital in a low-return environment.
Can 1058 service its debt comfortably?
Since total debt levels have outpaced equities, 1058 is a highly leveraged company. This is not unusual for small-caps as debt tends to be a cheaper and faster source of funding for some businesses. Though, since 1058 is currently unprofitable, there’s a question of sustainability of its current operations. Maintaining a high level of debt, while revenues are still below costs, can be dangerous as liquidity tends to dry up in unexpected downturns.
Next Steps:
Are you a shareholder? 1058’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. Though, its high liquidity ensures the company will continue to operate smoothly should unfavourable circumstances arise. Given that 1058’s financial situation may change. I recommend keeping abreast of market expectations for 1058’s future growth on our free analysis platform.