While small-cap stocks, such as Melcor Developments Ltd. (TSE:MRD) with its market cap of CA$423m, are popular for their explosive growth, investors should also be aware of their balance sheet to judge whether the company can survive a downturn. Evaluating financial health as part of your investment thesis is essential, as mismanagement of capital can lead to bankruptcies, which occur at a higher rate for small-caps. I believe these basic checks tell most of the story you need to know. Though, I know these factors are very high-level, so I recommend you dig deeper yourself into MRD here.
Does MRD produce enough cash relative to debt?
MRD's debt levels surged from CA$644m to CA$678m over the last 12 months – this includes long-term debt. With this rise in debt, MRD currently has CA$38m remaining in cash and short-term investments for investing into the business. On top of this, MRD has generated cash from operations of CA$1.4m during the same period of time, resulting in an operating cash to total debt ratio of 0.2%, indicating that MRD’s debt is not appropriately covered by operating cash. This ratio can also be a sign of operational efficiency as an alternative to return on assets. In MRD’s case, it is able to generate 0.002x cash from its debt capital.
Does MRD’s liquid assets cover its short-term commitments?
Looking at MRD’s CA$166m in current liabilities, it seems that the business has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 5.64x. Having said that, many consider a ratio above 3x to be high, although this is not necessarily a bad thing.
Can MRD service its debt comfortably?
With a debt-to-equity ratio of 60%, MRD can be considered as an above-average leveraged company. This is not unusual for small-caps as debt tends to be a cheaper and faster source of funding for some businesses. No matter how high the company’s debt, if it can easily cover the interest payments, it’s considered to be efficient with its use of excess leverage. A company generating earnings after interest and tax at least three times its net interest payments is considered financially sound. In MRD's case, the ratio of 4.36x suggests that interest is appropriately covered, which means that lenders may be less hesitant to lend out more funding as MRD’s high interest coverage is seen as responsible and safe practice.
MRD’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 MRD has company-specific issues impacting its capital structure decisions. You should continue to research Melcor Developments to get a better picture of the small-cap by looking at:
- Future Outlook: What are well-informed industry analysts predicting for MRD’s future growth? Take a look at our free research report of analyst consensus for MRD’s outlook.
- Valuation: What is MRD 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 MRD 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.
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