Quantum Energy Limited (ASX:QTM) is a small-cap-stock with a market capitalization of USD $15 Million. 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. The significance of doing due diligence on a company’s financial strength stems from the fact that over 20,000 companies go bankrupt in every quarter in the US alone.
Apart from geopolitical events such as political unrest and natural calamities, a company which is suddenly facing a hostile market environment must be able to fulfil short-term commitments with its reserves so that it can see another day. Thus, it becomes utmost important for an investor to test a company’s resilience for such contingencies. In simple terms, I believe these three small calculations tell most of the story you need to know. See our latest analysis for QTM
Does QTM generate enough cash through operations to meet all its needs?
More than the revenue shown on paper, what matters is how much cash is generated through operations and whether it is enough to continue operations, meet debt-obligations and fund growth. Over the past year, Quantum Energy’s operating cash flows stood at -11.8% of its overall debt. Quantum Energy currently has to rely on external funding to even run its business. This can be ok for a fast-growing company, but otherwise this is of course a sign of some serious debt-problems.
Can QTM meet its short-term obligations with the cash in hand?
This is to test Quantum Energy’s liquidity, which it may need due to a plethora of reasons that can derail the normal functioning of an organization in the short-term. It can be anything from natural calamity, political unrest, economic collapse, labor-strike, supply-chain disruption, or even a major factory breakdown, which can disrupt its normal functioning. However, banks, creditors, wages, and commitment to suppliers do not go away even during an extreme event. So, a company must maintain enough liquidity to meet its short-term obligations to survive. Quantum Energy is able to meet its short term (1 year) commitments with its holdings of cash and other short term assets.
Does Quantum Energy face the risk of succumbing to its debt-load?
Debt to equity ratio tells you if the company faces tough times or goes out of business, how much assets the debtors could claim. In the case of Quantum Energy, the debt-to-equity ratio is 63.4% and that means while Quantum Energy’s debt could pose a problem for its earnings stability, it’s not at an alarmingly high level yet. While debt-to-equity ratio has several factors at play, an easier way to check whether it’s at a sustainable level is to check its ability to service the debt. A company generating earnings at least 5x of its interest payments is considered financially sound. In addition, with such a coverage ratio, the earnings remain more stable. In QTM’s case the company is making a loss, therefore interest on debt is not well covered by earnings.
Conclusion
Clearly, Quantum Energy has a concerning amount of debt on its balance sheet. Additionally, the company fails to impress in terms of generating strong enough operating cash flows and earnings to cover annual interest expenses. Thus, for now, I don’t find it a financially sound company.
Now when you know whether you should keep the debt in mind as a risk factor when putting together your investment thesis, I recommend you check out our latest free analysis report on Quantum Energy to see what are QTM’s growth prospects and whether it could be considered an undervalued opportunity.
PS. If you are not interested in Quantum Energy anymore, you can use our free platform to see my list of over 150 other stocks with a high growth potential.