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Investors are always looking for growth in small-cap stocks like NewOcean Energy Holdings Limited (HKG:342), with a market cap of HK$3.1b. However, an important fact which most ignore is: how financially healthy is the business? Assessing first and foremost the financial health is crucial, as mismanagement of capital can lead to 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 just a partial view of the stock, and I’d encourage you to dig deeper yourself into 342 here.

Does 342 Produce Much Cash Relative To Its Debt?

Over the past year, 342 has ramped up its debt from HK$5.3b to HK$7.2b , which accounts for long term debt. With this increase in debt, 342 currently has HK$2.3b remaining in cash and short-term investments to keep the business going. Its negative operating cash flow means calculating cash-to-debt wouldn't be useful. As the purpose of this article is a high-level overview, I won’t be looking at this today, but you can examine some of 342’s operating efficiency ratios such as ROA here.

Does 342’s liquid assets cover its short-term commitments?

Looking at 342’s HK$6.3b in current liabilities, it appears that the company has been able to meet these obligations given the level of current assets of HK$12b, with a current ratio of 1.94x. The current ratio is the number you get when you divide current assets by current liabilities. For Oil and Gas companies, this ratio is within a sensible range since there is a bit of a cash buffer without leaving too much capital in a low-return environment.

Can 342 service its debt comfortably?

With debt reaching 96% of equity, 342 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 test if 342’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 342, the ratio of 5.54x suggests that interest is appropriately 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:

Although 342’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 342 has company-specific issues impacting its capital structure decisions. I recommend you continue to research NewOcean Energy Holdings to get a better picture of the small-cap by looking at:

1. Future Outlook: What are well-informed industry analysts predicting for 342’s future growth? Take a look at our free research report of analyst consensus for 342’s outlook.

2. Historical Performance: What has 342'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.

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.