Ching Lee Holdings Limited (HKG:3728) is a small-cap stock with a market capitalization of HK$233m. 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? Assessing first and foremost the financial health is vital, as mismanagement of capital can lead to bankruptcies, which occur at a higher rate for small-caps. Let's work through some financial health checks you may wish to consider if you're interested in this stock. However, these checks don't give you a full picture, so I suggest you dig deeper yourself into 3728 here.
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Does 3728 Produce Much Cash Relative To Its Debt?
3728's debt levels surged from HK$57m to HK$149m over the last 12 months made up of predominantly near term debt. With this growth in debt, the current cash and short-term investment levels stands at HK$77m , ready to be used for running the business. 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 examine some of 3728’s operating efficiency ratios such as ROA here.
Can 3728 meet its short-term obligations with the cash in hand?
With current liabilities at HK$355m, it appears that the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 1.15x. The current ratio is the number you get when you divide current assets by current liabilities. Usually, for Construction companies, this is a suitable ratio as there's enough of a cash buffer without holding too much capital in low return investments.
Can 3728 service its debt comfortably?
Since total debt levels exceed equity, 3728 is a highly 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. 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 before interest and tax (EBIT) at least three times its net interest payments is considered financially sound. In 3728's case, the ratio of 8.01x suggests that interest is appropriately covered, which means that lenders may be willing to lend out more funding as 3728’s high interest coverage is seen as responsible and safe practice.
Although 3728’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. This is only a rough assessment of financial health, and I'm sure 3728 has company-specific issues impacting its capital structure decisions. I recommend you continue to research Ching Lee Holdings to get a better picture of the small-cap by looking at:
- Future Outlook: What are well-informed industry analysts predicting for 3728’s future growth? Take a look at our free research report of analyst consensus for 3728’s outlook.
- Historical Performance: What has 3728's returns been like over the past? Go into more detail in the past track record analysis and take a look at the free visual representations of our analysis for more clarity.
- 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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If you spot an error that warrants correction, please contact the editor at email@example.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.