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While small-cap stocks, such as Schaffer Corporation Limited (ASX:SFC) with its market cap of AU$188m, are popular for their explosive growth, investors should also be aware of their balance sheet to judge whether the company can survive a downturn. Assessing first and foremost the financial health is essential, since poor capital management may bring about bankruptcies, which occur at a higher rate for small-caps. We’ll look at some basic checks that can form a snapshot the company’s financial strength. Nevertheless, potential investors would need to take a closer look, and I’d encourage you to dig deeper yourself into SFC here.
SFC’s Debt (And Cash Flows)
SFC has built up its total debt levels in the last twelve months, from AU$45m to AU$49m , which includes long-term debt. With this growth in debt, SFC currently has AU$35m remaining in cash and short-term investments , ready to be used for running the business. On top of this, SFC has generated AU$28m in operating cash flow in the last twelve months, resulting in an operating cash to total debt ratio of 57%, signalling that SFC’s operating cash is sufficient to cover its debt.
Can SFC pay its short-term liabilities?
At the current liabilities level of AU$47m, the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 2.46x. The current ratio is calculated by dividing current assets by current liabilities. Usually, for Auto Components companies, this is a suitable ratio since there’s a sufficient cash cushion without leaving too much capital idle or in low-earning investments.
Is SFC’s debt level acceptable?
With a debt-to-equity ratio of 45%, SFC can be considered as an above-average leveraged company. This is somewhat unusual for small-caps companies, since lenders are often hesitant to provide attractive interest rates to less-established businesses. We can test if SFC’s debt levels are sustainable by measuring interest payments against earnings of a company. Ideally, earnings before interest and tax (EBIT) should cover net interest by at least three times. For SFC, the ratio of 20.87x suggests that interest is comfortably covered, which means that debtors may be willing to loan the company more money, giving SFC ample headroom to grow its debt facilities.
Next Steps:
SFC’s high cash coverage means that, although its debt levels are high, the company is able to utilise its borrowings efficiently in order to generate cash flow. This may mean this is an optimal capital structure for the business, given that it is also meeting its short-term commitment. This is only a rough assessment of financial health, and I’m sure SFC has company-specific issues impacting its capital structure decisions. You should continue to research Schaffer to get a more holistic view of the small-cap by looking at:
- Future Outlook: What are well-informed industry analysts predicting for SFC’s future growth? Take a look at our free research report of analyst consensus for SFC’s outlook.
- Valuation: What is SFC worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether SFC is currently mispriced by the market.
- Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.