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Are China HGS Real Estate Inc.'s (NASDAQ:HGSH) Interest Costs Too High?

Simply Wall St

Investors are always looking for growth in small-cap stocks like China HGS Real Estate Inc. (NASDAQ:HGSH), with a market cap of US$41m. However, an important fact which most ignore is: how financially healthy is the business? Understanding the company's financial health becomes crucial, since poor capital management may bring about 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 suggest you dig deeper yourself into HGSH here.

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HGSH’s Debt (And Cash Flows)

HGSH's debt levels have fallen from US$132m to US$120m over the last 12 months , which includes long-term debt. With this reduction in debt, the current cash and short-term investment levels stands at US$1.0m to keep the business going. Additionally, HGSH has produced cash from operations of US$3.5m in the last twelve months, resulting in an operating cash to total debt ratio of 2.9%, indicating that HGSH’s debt is not covered by operating cash.

Can HGSH meet its short-term obligations with the cash in hand?

With current liabilities at US$144m, the company may not have an easy time meeting these commitments with a current assets level of US$133m, leading to a current ratio of 0.93x. The current ratio is calculated by dividing current assets by current liabilities.

NasdaqCM:HGSH Historical Debt, May 21st 2019

Is HGSH’s debt level acceptable?

With debt reaching 74% of equity, HGSH may be thought of as relatively highly levered. 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 HGSH 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 HGSH's, case, the ratio of 24.15x suggests that interest is comfortably covered, which means that lenders may be willing to lend out more funding as HGSH’s high interest coverage is seen as responsible and safe practice.

Next Steps:

Although HGSH’s debt level is towards the higher end of the spectrum, its cash flow coverage seems adequate to meet debt obligations which means its debt is being efficiently utilised. But, its low liquidity raises concerns over whether current asset management practices are properly implemented for the small-cap. This is only a rough assessment of financial health, and I'm sure HGSH has company-specific issues impacting its capital structure decisions. I recommend you continue to research China HGS Real Estate to get a more holistic view of the stock by looking at:

  1. Future Outlook: What are well-informed industry analysts predicting for HGSH’s future growth? Take a look at our free research report of analyst consensus for HGSH’s outlook.
  2. Valuation: What is HGSH worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether HGSH is currently mispriced by the market.
  3. Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.