Sing Lee Software (Group) Limited (SEHK:8076) is a small-cap stock with a market capitalization of HK$162.46M. 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 Software industry, even ones that are profitable, tend to be high risk. Assessing first and foremost the financial health is essential. Here are a few basic checks that are good enough to have a broad overview of the company’s financial strength. However, this commentary is still very high-level, so I’d encourage you to dig deeper yourself into 8076 here.
Does 8076 generate enough cash through operations?
8076’s debt levels surged from CN¥56.08M to CN¥64.96M over the last 12 months – this includes both the current and long-term debt. With this increase in debt, 8076’s cash and short-term investments stands at CN¥35.34M for investing into the business. On top of this, 8076 has generated CN¥12.93M in operating cash flow during the same period of time, resulting in an operating cash to total debt ratio of 19.90%, meaning that 8076’s debt is not appropriately covered by operating cash. This ratio can also be interpreted as a measure of efficiency as an alternative to return on assets. In 8076’s case, it is able to generate 0.2x cash from its debt capital.
Does 8076’s liquid assets cover its short-term commitments?
Looking at 8076’s most recent CN¥31.08M liabilities, it seems that the business has been able to meet these commitments with a current assets level of CN¥86.78M, leading to a 2.79x current account ratio. Generally, for Software 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 8076 face the risk of succumbing to its debt-load?
With total debt exceeding equities, 8076 is considered a highly levered company. This is not unusual for small-caps as debt tends to be a cheaper and faster source of funding for some businesses. 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 8076’s case, the ratio of 4.17x 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.