Investors are always looking for growth in small-cap stocks like Aceto Corporation (NASDAQ:ACET) with its market cap of USD $423 Million. However, an important fact which most ignore is: how financially healthy is the company? 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 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. These factors make a basic understanding of a company’s financial position of utmost importance for a new investor. Here are a few basic checks that are good enough to have a broad overview of the company’s financial strength. See our latest analysis for ACET
How does Aceto’s operating cash flow stack against its overall debt?
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. In the case of Aceto, operating cash flow turned out to be 12.5% of its overall debt over the past twelve months. This means while Aceto can cover its operating expenses, I would be cautious about its ability to service the debt should tougher times come.
Can ACET meet its short-term obligations with the cash in hand?
There are many problems that come unannounced. For instance, a hurricane or even labor strikes. In 2011, a Tsunami and earthquake in Japan had wiped out a significant chunk of auto supply chain in the country. If these were not Japan’s biggest automakers and electronics-maker with big cash reserves and funding sources, it’s hard to imagine how would they have recovered. For a small company, that could be a death blow if it doesn’t have enough reserves to meet its short-term obligations – payments to suppliers, wages, short-term bank loans, interest on long-term debt. Aceto is able to meet its short term (1 year) commitments with its holdings of cash and other short term assets.
Can ACET service its debt comfortably?
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 Aceto, the debt-to-equity ratio is 91.5% 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. 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 ACET’s case the interest on debt is well covered by earnings (3.7x coverage).
Aceto fails to impress in terms of its debt to equity ratio and operating cash flows compared to its overall-debt. However, the company does well on the earnings to interest-costs ratio. It appears ACET needs to reduce it’s debt-load and increase the operational efficiency to be categorized as a financially healthy 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 Aceto to see what are ACET’s growth prospects and whether it could be considered an undervalued opportunity.
PS. If you are not interested in Aceto anymore, you can use our free platform to see my list of over 150 other stocks with a high growth potential.