Paragon Care Limited (ASX:PGC) is a small-cap-stock with a market capitalization of USD $87 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 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 PGC
Does PGC 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, Paragon Care’s operating cash flows stood at 21.6% of its overall debt. That means Paragon Care’s core operations are generating enough cash to comfortably service its debt.
Does PGC’s cash and short-term assets cover its short-term commitments?
While failure to manage cash has been one of the major reasons behind the demise of a lot of small businesses, the mismanagement comes into the limelight during tough situations such as economic recession, war, natural disaster, sudden increase in the price of raw materials, and a supply chain risk, which can put a company in a difficult situation. 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. Paragon Care is able to meet its short term (1 year) commitments with its holdings of cash and other short term assets.
Can PGC service its debt comfortably?
While ideally I reckon the debt-to equity ratio of a financially healthy company to be less than 40%, several factors such as industry life-cycle and economic conditions can result in a company raising a significant amount of debt. For Paragon Care, the debt to equity ratio is 47.8% and this indicates that Paragon Care’s debt is at an acceptable level. 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 PGC’s case the interest on debt is well covered by earnings (7.3x coverage).
Whilst Paragon Care’s debt to equity ratio is high for my liking, it’s interest costs are well covered by it’s net income and the company’s operating cash flows are strong enough to fuel it’s future growth activities or pay dividends. Overall it’s in a strong financial position.
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 Paragon Care to see what are PGC’s growth prospects and whether it could be considered an undervalued opportunity.
PS. If you are not interested in Paragon Care anymore, you can use our free platform to see my list of over 150 other stocks with a high growth potential.