Investors are always looking for growth in small-cap stocks like Chu Kong Petroleum and Natural Gas Steel Pipe Holdings Limited (SEHK:1938), with a market cap of HK$707.80M. However, an important fact which most ignore is: how financially healthy is the business? Companies operating in the energy services industry, in particular ones that run negative earnings, are more likely to be higher risk. Evaluating financial health as part of your investment thesis is vital. Here are few basic financial health checks you should consider before taking the plunge. However, since I only look at basic financial figures, I suggest you dig deeper yourself into 1938 here.
How does 1938’s operating cash flow stack up against its debt?
1938 has sustained its debt level by about CN¥6,358.9M over the last 12 months – this includes both the current and long-term debt. At this constant level of debt, the current cash and short-term investment levels stands at CN¥472.5M , ready to deploy into the business. Moreover, 1938 has produced CN¥963.1M in operating cash flow in the last twelve months, leading to an operating cash to total debt ratio of 15.15%, signalling that 1938’s current level of operating cash is not high enough to cover debt. This ratio can also be a sign of operational efficiency for unprofitable companies since metrics such as return on asset (ROA) requires positive earnings. In 1938’s case, it is able to generate 0.15x cash from its debt capital.
Can 1938 pay its short-term liabilities?
At the current liabilities level of CN¥6,539.5M liabilities, the company has not maintained a sufficient level of current assets to meet its obligations, with the current ratio last standing at 0.58x, which is below the prudent industry ratio of 3x.
Does 1938 face the risk of succumbing to its debt-load?
Since total debt levels have outpaced equities, 1938 is a highly leveraged company. This is not uncommon for a small-cap company given that debt tends to be lower-cost and at times, more accessible. Though, since 1938 is presently unprofitable, sustainability of its current state of operations becomes a concern. 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? With a high level of debt on its balance sheet, 1938 could still be in a financially strong position if its cash flow also stacked up. However, this isn’t the case, and there’s room for 1938 to increase its 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. In the future, 1938’s financial situation may change. You should always be keeping abreast of market expectations for 1938’s future growth on our free analysis platform.