Is Leon’s Furniture Limited’s (TSE:LNF) Balance Sheet A Threat To Its Future?

Investors are always looking for growth in small-cap stocks like Leon’s Furniture Limited (TSE:LNF), with a market cap of CA$1.1b. However, an important fact which most ignore is: how financially healthy is the business? Companies operating in the Specialty Retail industry facing headwinds from current disruption, even ones that are profitable, tend to be high risk. So, understanding the company’s financial health becomes crucial. I believe these basic checks tell most of the story you need to know. However, given that I have not delve into the company-specifics, I suggest you dig deeper yourself into LNF here.

How does LNF’s operating cash flow stack up against its debt?

Over the past year, LNF has reduced its debt from CA$313m to CA$223m , which also accounts for long term debt. With this reduction in debt, the current cash and short-term investment levels stands at CA$129m , ready to deploy into the business. On top of this, LNF has produced CA$145m in operating cash flow during the same period of time, resulting in an operating cash to total debt ratio of 65%, indicating that LNF’s operating cash is sufficient to cover its debt. This ratio can also be interpreted as a measure of efficiency as an alternative to return on assets. In LNF’s case, it is able to generate 0.65x cash from its debt capital.

Can LNF meet its short-term obligations with the cash in hand?

Looking at LNF’s CA$374m in current liabilities, it seems that the business has been able to meet these commitments with a current assets level of CA$580m, leading to a 1.55x current account ratio. Generally, for Specialty Retail companies, this is a reasonable ratio as there’s enough of a cash buffer without holding too much capital in low return investments.

TSX:LNF Historical Debt November 29th 18
TSX:LNF Historical Debt November 29th 18

Does LNF face the risk of succumbing to its debt-load?

LNF’s level of debt is appropriate relative to its total equity, at 27%. This range is considered safe as LNF is not taking on too much debt obligation, which may be constraining for future growth. We can test if LNF’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 LNF, the ratio of 19.79x suggests that interest is comfortably covered, which means that debtors may be willing to loan the company more money, giving LNF ample headroom to grow its debt facilities.

Next Steps:

LNF’s debt level is appropriate for a company its size, and it is also able to generate sufficient cash flow coverage, meaning it has been able to put its debt in good use. In addition to this, the company will be able to pay all of its upcoming liabilities from its current short-term assets. This is only a rough assessment of financial health, and I’m sure LNF has company-specific issues impacting its capital structure decisions. You should continue to research Leon’s Furniture to get a better picture of the stock by looking at:

  1. Future Outlook: What are well-informed industry analysts predicting for LNF’s future growth? Take a look at our free research report of analyst consensus for LNF’s outlook.
  2. Valuation: What is LNF 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 LNF 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.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.