You Might Like Hammond Power Solutions Inc. (TSE:HPS.A) But Do You Like Its Debt?

While small-cap stocks, such as Hammond Power Solutions Inc. (TSE:HPS.A) with its market cap of CA$84m, are popular for their explosive growth, investors should also be aware of their balance sheet to judge whether the company can survive a downturn. Understanding the company's financial health becomes essential, since poor capital management may bring about bankruptcies, which occur at a higher rate for small-caps. The following basic checks can help you get a picture of the company's balance sheet strength. Nevertheless, potential investors would need to take a closer look, and I’d encourage you to dig deeper yourself into HPS.A here.

Does HPS.A Produce Much Cash Relative To Its Debt?

HPS.A has built up its total debt levels in the last twelve months, from CA$28m to CA$33m . With this rise in debt, HPS.A currently has CA$16m remaining in cash and short-term investments , ready to be used for running the business. Moreover, HPS.A has produced CA$6.5m in operating cash flow during the same period of time, leading to an operating cash to total debt ratio of 20%, signalling that HPS.A’s operating cash is less than its debt.

Can HPS.A pay its short-term liabilities?

At the current liabilities level of CA$94m, it seems that the business has been able to meet these commitments with a current assets level of CA$138m, leading to a 1.47x current account ratio. The current ratio is the number you get when you divide current assets by current liabilities. Usually, for Electrical companies, this is a suitable ratio since there is a bit of a cash buffer without leaving too much capital in a low-return environment.

Can HPS.A service its debt comfortably?

With a debt-to-equity ratio of 30%, HPS.A's debt level may be seen as prudent. HPS.A is not taking on too much debt commitment, which can be restrictive and risky for equity-holders. We can test if HPS.A’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 HPS.A, the ratio of 22.44x suggests that interest is comfortably covered, which means that lenders may be inclined to lend more money to the company, as it is seen as safe in terms of payback.

Next Steps:

HPS.A has demonstrated its ability to generate sufficient levels of cash flow, while its debt hovers at an appropriate level. Furthermore, the company exhibits an ability to meet its near term obligations should an adverse event occur. This is only a rough assessment of financial health, and I'm sure HPS.A has company-specific issues impacting its capital structure decisions. I recommend you continue to research Hammond Power Solutions to get a better picture of the stock by looking at:

1. Future Outlook: What are well-informed industry analysts predicting for HPS.A’s future growth? Take a look at our free research report of analyst consensus for HPS.A’s outlook.
2. Valuation: What is HPS.A 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 HPS.A is currently mispriced by the market.
3. 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.

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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.