Zhong An Real Estate Limited (HKG:672) is a small-cap stock with a market capitalization of HK$1.8b. 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 crucial, 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, potential investors would need to take a closer look, and I recommend you dig deeper yourself into 672 here.

Does 672 Produce Much Cash Relative To Its Debt?

Over the past year, 672 has maintained its debt levels at around CN¥4.8b which accounts for long term debt. At this current level of debt, 672 currently has CN¥1.6b remaining in cash and short-term investments to keep the business going. 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 672’s operating efficiency ratios such as ROA here.

Can 672 pay its short-term liabilities?

At the current liabilities level of CN¥9.9b, the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 1.52x. The current ratio is the number you get when you divide current assets by current liabilities. Generally, for Real Estate companies, this is a reasonable ratio since there's a sufficient cash cushion without leaving too much capital idle or in low-earning investments.

Can 672 service its debt comfortably?

With debt reaching 50% of equity, 672 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. We can test if 672’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 672, the ratio of 18.94x suggests that interest is comfortably 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:

672’s high cash coverage means that, although its debt levels are high, the company is able to utilise its borrowings efficiently in order to generate cash flow. 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 672's financial health. Other important fundamentals need to be considered alongside. I suggest you continue to research Zhong An Real Estate to get a more holistic view of the small-cap by looking at:

1. Future Outlook: What are well-informed industry analysts predicting for 672’s future growth? Take a look at our free research report of analyst consensus for 672’s outlook.

2. Historical Performance: What has 672'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.

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.

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