What does Datang Environment Industry Group Co Ltd's (HKG:1272) Balance Sheet Tell Us About Its Future?

Datang Environment Industry Group Co Ltd (HKG:1272) is a small-cap stock with a market capitalization of HK$6.5b. 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 essential, since poor capital management may bring about bankruptcies, which occur at a higher rate for small-caps. Here are a few basic checks that are good enough to have a broad overview of the company’s financial strength. However, this commentary is still very high-level, so I’d encourage you to dig deeper yourself into 1272 here.

Does 1272 produce enough cash relative to debt?

1272's debt levels surged from CN¥4.2b to CN¥4.7b over the last 12 months , which includes long-term debt. With this increase in debt, 1272's cash and short-term investments stands at CN¥1.7b for investing into the business. On top of this, 1272 has generated cash from operations of CN¥885m over the same time period, resulting in an operating cash to total debt ratio of 19%, indicating that 1272’s current level of operating cash is not high enough to cover debt. This ratio can also be a sign of operational efficiency as an alternative to return on assets. In 1272’s case, it is able to generate 0.19x cash from its debt capital.

Can 1272 pay its short-term liabilities?

Looking at 1272’s CN¥8.4b in current liabilities, it seems that the business has been able to meet these commitments with a current assets level of CN¥10b, leading to a 1.23x current account ratio. Generally, for Commercial Services companies, this is a reasonable ratio as there's enough of a cash buffer without holding too much capital in low return investments.

Is 1272’s debt level acceptable?

1272 is a relatively highly levered company with a debt-to-equity of 69%. This is not unusual for small-caps as debt tends to be a cheaper and faster source of funding for some businesses. We can test if 1272’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 1272, the ratio of 7.07x suggests that interest is appropriately covered, which means that debtors may be willing to loan the company more money, giving 1272 ample headroom to grow its debt facilities.

Next Steps:

1272’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. This is only a rough assessment of financial health, and I'm sure 1272 has company-specific issues impacting its capital structure decisions. I recommend you continue to research Datang Environment Industry Group to get a more holistic view of the small-cap by looking at:

1. Future Outlook: What are well-informed industry analysts predicting for 1272’s future growth? Take a look at our free research report of analyst consensus for 1272’s outlook.
2. Historical Performance: What has 1272'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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The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.

Simply Wall St analyst Simply Wall St and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.