Investors are always looking for growth in small-cap stocks like Chevalier International Holdings Limited (SEHK:25), with a market cap of HK$3.85B. However, an important fact which most ignore is: how financially healthy is the business? Evaluating financial health as part of your investment thesis is crucial, as mismanagement of capital can lead to bankruptcies, which occur at a higher rate for small-caps. Here are a few basic checks that are good enough to have a broad overview of the company’s financial strength. However, given that I have not delve into the company-specifics, I’d encourage you to dig deeper yourself into 25 here.
How does 25’s operating cash flow stack up against its debt?
25 has shrunken its total debt levels in the last twelve months, from HK$3,112.5M to HK$2,790.4M , which comprises of short- and long-term debt. With this reduction in debt, 25’s cash and short-term investments stands at HK$2,316.4M , ready to deploy into the business. Moreover, 25 has generated HK$126.8M in operating cash flow in the last twelve months, resulting in an operating cash to total debt ratio of 0.05x, signalling that 25’s current level of operating cash is not high enough to cover debt. This ratio can also be interpreted as a measure of efficiency as an alternative to return on assets. In 25’s case, it is able to generate 0.05x cash from its debt capital.
Does 25’s liquid assets cover its short-term commitments?
With current liabilities at HK$3,872.9M liabilities, it appears that the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 1.64x. Generally, for industrials 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.
Does 25 face the risk of succumbing to its debt-load?
With a debt-to-equity ratio of 35.57%, 25’s debt level may be seen as prudent. This range is considered safe as 25 is not taking on too much debt obligation, which can be restrictive and risky for equity-holders. We can test if 25’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 25, the ratio of 8.24x suggests that interest is appropriately covered, which means that lenders may be less hesitant to lend out more funding as 25’s high interest coverage is seen as responsible and safe practice.
Next Steps:
Are you a shareholder? 25’s low debt is also met with low coverage. This indicates room for improvement as its cash flow covers less than a quarter of its borrowings, which means its operating efficiency could be better. Though, the company will be able to pay all of its upcoming liabilities from its current short-term assets. Given that its financial position may change. You should always be keeping on top of market expectations for 25’s future growth on our free analysis platform.