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Ching Lee Holdings Limited (HKG:3728) is a small-cap stock with a market capitalization of HK$233m. 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 vital, as mismanagement of capital can lead to bankruptcies, which occur at a higher rate for small-caps. Let's work through some financial health checks you may wish to consider if you're interested in this stock. However, these checks don't give you a full picture, so I suggest you dig deeper yourself into 3728 here.
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Does 3728 Produce Much Cash Relative To Its Debt?
3728's debt levels surged from HK$57m to HK$149m over the last 12 months made up of predominantly near term debt. With this growth in debt, the current cash and short-term investment levels stands at HK$77m , ready to be used for running the business. Moving on, operating cash flow was negative over the last twelve months. For this article’s sake, I won’t be looking at this today, but you can examine some of 3728’s operating efficiency ratios such as ROA here.
Can 3728 meet its short-term obligations with the cash in hand?
With current liabilities at HK$355m, it appears that the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 1.15x. The current ratio is the number you get when you divide current assets by current liabilities. Usually, for Construction companies, this is a suitable ratio as there's enough of a cash buffer without holding too much capital in low return investments.
Can 3728 service its debt comfortably?
Since total debt levels exceed equity, 3728 is a highly leveraged company. This is a bit unusual for a small-cap stock, since they generally have a harder time borrowing than large more established companies. No matter how high the company’s debt, if it can easily cover the interest payments, it’s considered to be efficient with its use of excess leverage. A company generating earnings before interest and tax (EBIT) at least three times its net interest payments is considered financially sound. In 3728's case, the ratio of 8.01x suggests that interest is appropriately covered, which means that lenders may be willing to lend out more funding as 3728’s high interest coverage is seen as responsible and safe practice.