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China Electronics Huada Technology Company Limited (HKG:85) is a small-cap stock with a market capitalization of HK$1.8b. 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? Companies operating in the Semiconductor industry, even ones that are profitable, are inclined towards being higher risk. So, understanding the company’s financial health becomes essential. Here are few basic financial health checks you should consider before taking the plunge. Though, I know these factors are very high-level, so I’d encourage you to dig deeper yourself into 85 here.
How much cash does 85 generate through its operations?
85 has sustained its debt level by about HK$2.3b over the last 12 months , which is mainly comprised of near term debt. At this stable level of debt, the current cash and short-term investment levels stands at HK$480m for investing into the business. Moving onto cash from operations, its small level of operating cash flow means calculating cash-to-debt wouldn’t be too useful, though these low levels of cash means that operational efficiency is worth a look. As the purpose of this article is a high-level overview, I won’t be looking at this today, but you can examine some of 85’s operating efficiency ratios such as ROA here.
Does 85’s liquid assets cover its short-term commitments?
At the current liabilities level of HK$3.2b, it appears that the company may not be able to easily meet these obligations given the level of current assets of HK$2.0b, with a current ratio of 0.62x.
Does 85 face the risk of succumbing to its debt-load?
With total debt exceeding equities, 85 is considered a highly levered company. This is not uncommon for a small-cap company given that debt tends to be lower-cost and at times, more accessible. 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 after interest and tax at least three times its net interest payments is considered financially sound. In 85’s case, the ratio of 1.02x suggests that interest is not strongly covered, which means that lenders may refuse to lend the company more money, as it is seen as too risky in terms of default.
Next Steps:
Although 85’s debt level is towards the higher end of the spectrum, its cash flow coverage seems adequate to meet debt obligations which means its debt is being efficiently utilised. But, its lack of liquidity raises questions over current asset management practices for the small-cap. I admit this is a fairly basic analysis for 85’s financial health. Other important fundamentals need to be considered alongside. You should continue to research China Electronics Huada Technology to get a better picture of the stock by looking at: