Optibase Ltd (NASDAQ:OBAS) is a small-cap-stock with a market capitalization of USD $42 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. There are always disruptions which destabilize and many a times end an existing industry, and most small-cap companies are the first casualties when such a wave hits.
Apart from a major industry-downturn like in the energy sector, it can be anything from natural calamity; political unrest; economic collapse; labor-strike; supply-chain disruption; or even a major factory breakdown, which may test a company’s financial resilience. Here are few basic financial health checks to judge whether a company fits the bill or there is an additional risk which you should consider before taking the plunge. Check out our latest analysis for Optibase
How does Optibase’s operating cash flow stack against its overall debt?
While in short-term operating cash flows can be volatile, on an annual basis, they reflect the true picture of a company’s earnings quality and its ability to meet obligations. Over the past year, Optibase’s operating cash flows stood at 4.5% of its overall debt. An annual operating cash flow of less than a tenth of the overall debt raises red flags, although short-term obstacles and cyclical nature of an industry may have an impact on a company’s ability to generate cash.
Does OBAS’s cash and short-term assets cover its short-term commitments?
This is to test Optibase’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. But that does not absolve the company from its obligations such as lease payments, interest payments, and salaries. In addition, failure to service debt and bank loans can dreadfully hurts its reputation, making funding extremely expensive in the future, if at all it survives. Optibase short term (1 year) commitments are greater than its holdings of cash and other short term assets.
Does Optibase face the risk of succumbing to its debt-load?
A substantially higher-debt poses a significant threat to a company’s profitability during a downturn. Optibase’s debt to equity ratio stands at 210.9% and this indicates that the company is holding a high level of debt / liabilities compared to its net worth, and in the event of financial stress may experience difficulty meeting debt or interest obligations. No matter how high is the debt, if a company can easily cover the interest payments, it’s considered to be making a good use of that excessive leverage. To keep an eye on how it’s doing on that front, an investor can check how easily the company can service its debt. If it earns at least 5x or more of its interest payments, that’s an indication of financial strength. In OBAS’s case the interest on debt is not strongly covered (ideally 5x) by earnings (earnings are 0.1x annual interest expense).
Clearly, Optibase 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 Optibase to see what are OBAS’s growth prospects and whether it could be considered an undervalued opportunity.
PS. If you are not interested in Optibase anymore, you can use our free platform to see my list of over 150 other stocks with a high growth potential.