Tongda Group Holdings Limited (SEHK:698) is a small-cap stock with a market capitalization of HK$12.22B. 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 electronic industry, even ones that are profitable, are inclined towards being higher risk. Assessing first and foremost the financial health is vital. I believe these basic checks tell most of the story you need to know. Though, I know these factors are very high-level, so I suggest you dig deeper yourself into 698 here.
Does 698 generate enough cash through operations?
Over the past year, 698 has ramped up its debt from HK$2,368.7M to HK$2,976.3M , which comprises of short- and long-term debt. With this increase in debt, the current cash and short-term investment levels stands at HK$869.1M , ready to deploy into the business. Additionally, 698 has produced cash from operations of HK$1,109.6M in the last twelve months, leading to an operating cash to total debt ratio of 37.28%, meaning that 698’s debt is appropriately covered by operating cash. This ratio can also be a sign of operational efficiency as an alternative to return on assets. In 698’s case, it is able to generate 0.37x cash from its debt capital.
Can 698 pay its short-term liabilities?
With current liabilities at HK$4,332.8M liabilities, it appears that the company has been able to meet these obligations given the level of current assets of HK$6,713.9M, with a current ratio of 1.55x. For electronic companies, this ratio is within a sensible range since there is a bit of a cash buffer without leaving too much capital in a low-return environment.
Is 698’s level of debt at an acceptable level?
With debt reaching 64.94% of equity, 698 may be thought of as relatively highly levered. 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 698’s case, the ratio of 13.98x suggests that interest is excessively 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? Although 698’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. Since there is also no concerns around 698’s liquidity needs, this may be its optimal capital structure for the time being. In the future, its financial position may change. I suggest keeping on top of market expectations for 698’s future growth on our free analysis platform.