Are Encanto Potash Corp's (CVE:EPO) Interest Costs Too High?

Encanto Potash Corp (TSXV:EPO) is a small-cap stock with a market capitalization of CA$22.04M. 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. Why is it important? Since EPO is loss-making right now, it’s crucial to assess the current state of its operations and pathway to profitability. I believe these basic checks tell most of the story you need to know. Though, since I only look at basic financial figures, I recommend you dig deeper yourself into EPO here.

Does EPO generate an acceptable amount of cash through operations?

EPO's debt level has been constant at around CA$7.20M over the previous year comprising of short- and long-term debt. At this stable level of debt, EPO currently has CA$1.16M remaining in cash and short-term investments for investing into the business. Moving onto cash from operations, its trivial cash flows from operations make the cash-to-debt ratio less useful to us, though these low levels of cash means that operational efficiency is worth a look. As the purpose of this article is a high-level overview, I won’t be looking at this today, but you can take a look at some of EPO’s operating efficiency ratios such as ROA here.

Does EPO’s liquid assets cover its short-term commitments?

Looking at EPO’s most recent CA$17.51M liabilities, the company has not been able to meet these commitments with a current assets level of CA$1.34M, leading to a 0.077x current account ratio. which is under the appropriate industry ratio of 3x.

Can EPO service its debt comfortably?

EPO is a relatively highly levered company with a debt-to-equity of 78.75%. This is not unusual for small-caps as debt tends to be a cheaper and faster source of funding for some businesses. But since EPO is presently loss-making, sustainability of its current state of operations becomes a concern. Maintaining a high level of debt, while revenues are still below costs, can be dangerous as liquidity tends to dry up in unexpected downturns.

Next Steps:

At its current level of cash flow coverage, EPO has room for improvement to better cushion for events which may require debt repayment. Furthermore, its low liquidity raises concerns over whether current asset management practices are properly implemented for the small-cap. This is only a rough assessment of financial health, and I'm sure EPO has company-specific issues impacting its capital structure decisions. You should continue to research Encanto Potash to get a more holistic view of the stock by looking at:

• 1. Valuation: What is EPO 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 EPO is currently mispriced by the market.
• 2. Historical Performance: What has EPO's returns been like over the past? Go into more detail in the past track record analysis and take a look at the free visual representations of our analysis for more clarity.
• 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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Simply Wall St analyst Simply Wall St and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.