While small-cap stocks, such as China Animation Characters Company Limited (HKG:1566) with its market cap of HK$1.8b, 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 essential, 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. Nevertheless, these checks don't give you a full picture, so I recommend you dig deeper yourself into 1566 here.
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Does 1566 Produce Much Cash Relative To Its Debt?
Over the past year, 1566 has ramped up its debt from HK$440m to HK$566m – this includes long-term debt. With this increase in debt, 1566 currently has HK$81m remaining in cash and short-term investments , ready to be used for running the business. Moreover, 1566 has generated HK$430m in operating cash flow over the same time period, resulting in an operating cash to total debt ratio of 76%, meaning that 1566’s current level of operating cash is high enough to cover debt.
Does 1566’s liquid assets cover its short-term commitments?
At the current liabilities level of HK$524m, it seems that the business has been able to meet these obligations given the level of current assets of HK$627m, with a current ratio of 1.2x. The current ratio is the number you get when you divide current assets by current liabilities. Usually, for Retail Distributors companies, this is a suitable ratio since there is a bit of a cash buffer without leaving too much capital in a low-return environment.
Can 1566 service its debt comfortably?
With a debt-to-equity ratio of 63%, 1566 can be considered as an above-average leveraged company. 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 test if 1566’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 1566, the ratio of 1.57x suggests that interest is not strongly covered, which means that lenders may be more reluctant to lend out more funding as 1566’s low interest coverage already puts the company at higher risk of default.
Although 1566’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. I admit this is a fairly basic analysis for 1566's financial health. Other important fundamentals need to be considered alongside. I suggest you continue to research China Animation Characters to get a better picture of the small-cap by looking at:
- Future Outlook: What are well-informed industry analysts predicting for 1566’s future growth? Take a look at our free research report of analyst consensus for 1566’s outlook.
- Valuation: What is 1566 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 1566 is currently mispriced by the market.
- 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.
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