While small-cap stocks, such as Raffles United Holdings Ltd (SGX:K22) with its market cap of S$29.26m, are popular for their explosive growth, investors should also be aware of their balance sheet to judge whether the company can survive a downturn. So, understanding the company’s financial health becomes 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. Though, this commentary is still very high-level, so I suggest you dig deeper yourself into K22 here.
Does K22 produce enough cash relative to debt?
K22’s debt level has been constant at around S$37.75m over the previous year – this includes both the current and long-term debt. At this stable level of debt, K22 currently has S$6.42m remaining in cash and short-term investments , ready to deploy into the business. On top of this, K22 has generated cash from operations of S$11.05m in the last twelve months, resulting in an operating cash to total debt ratio of 29.28%, meaning that K22’s debt is appropriately covered by operating cash. This ratio can also be interpreted as a measure of efficiency as an alternative to return on assets. In K22’s case, it is able to generate 0.29x cash from its debt capital.
Does K22’s liquid assets cover its short-term commitments?
With current liabilities at S$36.94m, it seems that the business has been able to meet these commitments with a current assets level of S$53.21m, leading to a 1.44x current account ratio. Generally, for Trade Distributors 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.
Can K22 service its debt comfortably?
With debt reaching 45.27% of equity, K22 may be thought of as relatively highly levered. This is not uncommon for a small-cap company given that debt tends to be lower-cost and at times, more accessible. We can test if K22’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 K22, the ratio of 4.39x suggests that interest is appropriately covered, which means that lenders may be less hesitant to lend out more funding as K22’s high interest coverage is seen as responsible and safe practice.
Next Steps:
K22’s high cash coverage means that, although its debt levels are high, the company is able to utilise its borrowings efficiently in order to generate cash flow. Since there is also no concerns around K22’s liquidity needs, this may be its optimal capital structure for the time being. This is only a rough assessment of financial health, and I’m sure K22 has company-specific issues impacting its capital structure decisions. You should continue to research Raffles United Holdings to get a better picture of the small-cap by looking at: