US Geothermal Inc (AMEX:HTM) is a small-cap-stock with a market capitalization of USD $76 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. 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 U.S. Geothermal
Does U.S. Geothermal generate an acceptable amount of cash through operations?
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. For U.S. Geothermal the ratio of operating cash flow to overall debt stands at 9.4%. A figure of less than 10% is alarming, although short-term obstacles and cyclical nature of an industry may have an impact on a company’s ability to generate cash.
Can HTM pay its short-term debts?
This is to test U.S. Geothermal’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. U.S. Geothermal is able to meet its short term (1 year) commitments with its holdings of cash and other short term assets.
Does U.S. Geothermal 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 U.S. Geothermal, the debt-to-equity ratio is 81.1% and this means that U.S. Geothermal is a highly leveraged company, which can be fine if the company has consistently improved its Return on Equity. But a business downturn may dry up its liquidity, making it hard to operate. 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 HTM’s case the interest on debt is not strongly covered (ideally 3x) by earnings (ebit is 1.5x annual interest expense).
Clearly, U.S. Geothermal 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 U.S. Geothermal to see what are HTM’s growth prospects and whether it could be considered an undervalued opportunity.
PS. If you are not interested in U.S. Geothermal anymore, you can use our free platform to see my list of over 150 other stocks with a high growth potential.