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While small-cap stocks, such as Skyworth Digital Holdings Limited (HKG:751) with its market cap of HK$6.2b, are popular for their explosive growth, investors should also be aware of their balance sheet to judge whether the company can survive a downturn. Assessing first and foremost the financial health is vital, since poor capital management may bring about bankruptcies, which occur at a higher rate for small-caps. The following basic checks can help you get a picture of the company's balance sheet strength. However, potential investors would need to take a closer look, and I recommend you dig deeper yourself into 751 here.
Does 751 Produce Much Cash Relative To Its Debt?
751's debt levels have fallen from CN¥9.7b to CN¥8.3b over the last 12 months – this includes long-term debt. With this reduction in debt, the current cash and short-term investment levels stands at CN¥3.5b to keep the business going. Moving on, operating cash flow was negative over the last twelve months. For this article’s sake, I won’t be looking at this today, but you can assess some of 751’s operating efficiency ratios such as ROA here.
Can 751 pay its short-term liabilities?
With current liabilities at CN¥24b, it appears that the company has been able to meet these obligations given the level of current assets of CN¥33b, with a current ratio of 1.36x. The current ratio is calculated by dividing current assets by current liabilities. Generally, for Consumer Durables companies, this is a reasonable ratio as there's enough of a cash buffer without holding too much capital in low return investments.
Does 751 face the risk of succumbing to its debt-load?
With a debt-to-equity ratio of 48%, 751 can be considered as an above-average leveraged company. This is somewhat unusual for small-caps companies, since lenders are often hesitant to provide attractive interest rates to less-established businesses. We can test if 751’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 751, the ratio of 10.76x suggests that interest is comfortably covered, which means that lenders may be willing to lend out more funding as 751’s high interest coverage is seen as responsible and safe practice.
Next Steps:
Although 751’s debt level is towards the higher end of the spectrum, its cash flow coverage seems adequate to meet obligations which means its debt is being efficiently utilised. This may mean this is an optimal capital structure for the business, given that it is also meeting its short-term commitment. Keep in mind I haven't considered other factors such as how 751 has been performing in the past. I suggest you continue to research Skyworth Digital Holdings to get a more holistic view of the small-cap by looking at: