In This Article:
Want to participate in a short research study? Help shape the future of investing tools and you could win a $250 gift card!
South China Holdings Company Limited (HKG:413) is a small-cap stock with a market capitalization of HK$2.4b. 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? Evaluating financial health as part of your investment thesis is essential, as mismanagement of capital can lead to bankruptcies, which occur at a higher rate for small-caps. We'll look at some basic checks that can form a snapshot the company’s financial strength. Nevertheless, this is not a comprehensive overview, so I recommend you dig deeper yourself into 413 here.
Does 413 Produce Much Cash Relative To Its Debt?
413's debt levels surged from HK$4.3b to HK$4.8b over the last 12 months – this includes long-term debt. With this growth in debt, 413 currently has HK$864m remaining in cash and short-term investments to keep the business going. We note it produced negative cash flow over the last twelve months. For this article’s sake, I won’t be looking at this today, but you can examine some of 413’s operating efficiency ratios such as ROA here.
Can 413 pay its short-term liabilities?
Looking at 413’s HK$4.1b in current liabilities, the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 1.26x. The current ratio is the number you get when you divide current assets by current liabilities. Generally, for Leisure 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.
Is 413’s debt level acceptable?
413 is a relatively highly levered company with a debt-to-equity of 80%. This is a bit unusual for a small-cap stock, since they generally have a harder time borrowing than large more established companies. We can check to see whether 413 is able to meet its debt obligations by looking at the net interest coverage ratio. A company generating earnings before interest and tax (EBIT) at least three times its net interest payments is considered financially sound. In 413's, case, the ratio of 0.15x suggests that interest is not strongly covered, which means that debtors may be less inclined to loan the company more money, reducing its headroom for growth through debt.
Next Steps:
413’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. 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 413 has been performing in the past. I recommend you continue to research South China Holdings to get a more holistic view of the small-cap by looking at: