While small-cap stocks, such as Ouhua Energy Holdings Limited (SGX:AJ2) with its market cap of SGD19.93M, are popular for their explosive growth, investors should also be aware of their balance sheet to judge whether the company can survive a downturn. Companies operating in the oil and gas industry, even ones that are profitable, are more likely to be higher risk. Assessing first and foremost the financial health is crucial. 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 suggest you dig deeper yourself into AJ2 here.
Does AJ2 generate enough cash through operations?
Over the past year, AJ2 has reduced its debt from CN¥386.2M to CN¥315.7M , which is mainly comprised of near term debt. With this debt payback, AJ2’s cash and short-term investments stands at CN¥91.4M for investing into the business. Additionally, AJ2 has generated CN¥53.3M in operating cash flow in the last twelve months, leading to an operating cash to total debt ratio of 0.17x, indicating that AJ2’s debt is not appropriately covered by operating cash. This ratio can also be a sign of operational efficiency as an alternative to return on assets. In AJ2’s case, it is able to generate 0.17x cash from its debt capital.
Can AJ2 pay its short-term liabilities?
With current liabilities at CN¥479.6M liabilities, it seems that the business has not maintained a sufficient level of current assets to meet its obligations, with the current ratio last standing at 0.92x, which is below the prudent industry ratio of 3x.
Does AJ2 face the risk of succumbing to its debt-load?
AJ2 is a highly-leveraged company with debt exceeding equity by over 100%. 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 AJ2’s case, the ratio of 4.63x suggests that interest is appropriately covered, which means that lenders may be inclined to lend more money to the company, as it is seen as safe in terms of payback.
Next Steps:
Are you a shareholder? AJ2’s high debt level indicates room for improvement. Furthermore, its cash flow coverage of less than a quarter of debt means that operating efficiency could also be an issue. In addition to this, the company may struggle to meet its near term liabilities should an adverse event occur. In the future, its financial position may be different. You should always be keeping abreast of market expectations for AJ2’s future growth on our free analysis platform.