You Might Like CAA Resources Limited (HKG:2112) But Do You Like Its Debt?
CAA Resources Limited (HKG:2112) is a small-cap stock with a market capitalization of HK$2.2b. 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? Understanding the company's financial health becomes 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 2112 here.
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2112’s Debt (And Cash Flows)
Over the past year, 2112 has reduced its debt from US$157m to US$138m – this includes long-term debt. With this debt payback, 2112 currently has US$183k remaining in cash and short-term investments , ready to be used for running the business. Additionally, 2112 has produced US$19m in operating cash flow in the last twelve months, leading to an operating cash to total debt ratio of 14%, indicating that 2112’s debt is not covered by operating cash.
Can 2112 meet its short-term obligations with the cash in hand?
Looking at 2112’s US$146m in current liabilities, it seems that the business has been able to meet these obligations given the level of current assets of US$215m, with a current ratio of 1.47x. The current ratio is calculated by dividing current assets by current liabilities. Usually, for Trade 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 2112 service its debt comfortably?
With debt reaching 90% of equity, 2112 may be thought of as relatively highly levered. This is somewhat unusual for small-caps companies, since lenders are often hesitant to provide attractive interest rates to less-established 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 before interest and tax (EBIT) at least three times its net interest payments is considered financially sound. In 2112's case, the ratio of 1.44x suggests that interest is not strongly covered, which means that lenders may be more reluctant to lend out more funding as 2112’s low interest coverage already puts the company at higher risk of default.
Next Steps:
Although 2112’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 2112's liquidity needs, this may be its optimal capital structure for the time being. This is only a rough assessment of financial health, and I'm sure 2112 has company-specific issues impacting its capital structure decisions. I suggest you continue to research CAA Resources to get a better picture of the small-cap by looking at:
Future Outlook: What are well-informed industry analysts predicting for 2112’s future growth? Take a look at our free research report of analyst consensus for 2112’s outlook.
Valuation: What is 2112 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 2112 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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