Is Roots Corporation (TSE:ROOT) A Financially Sound Company?

While small-cap stocks, such as Roots Corporation (TSE:ROOT) with its market cap of CA$169m, 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 vital, as mismanagement of capital can lead to 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, this is not a comprehensive overview, so I’d encourage you to dig deeper yourself into ROOT here.

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ROOT’s Debt (And Cash Flows)

ROOT’s debt levels surged from CA$85m to CA$98m over the last 12 months , which accounts for long term debt. With this growth in debt, ROOT’s cash and short-term investments stands at CA$2.0m , ready to be used for running the business. On top of this, ROOT has generated CA$19m in operating cash flow in the last twelve months, resulting in an operating cash to total debt ratio of 20%, meaning that ROOT’s operating cash is less than its debt.

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

Looking at ROOT’s CA$52m 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 1.26x. The current ratio is calculated by dividing current assets by current liabilities. Usually, for Specialty Retail companies, this is a suitable ratio since there’s a sufficient cash cushion without leaving too much capital idle or in low-earning investments.

TSX:ROOT Historical Debt, May 21st 2019
TSX:ROOT Historical Debt, May 21st 2019

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

With debt reaching 46% of equity, ROOT may be thought of as relatively highly levered. This is a bit unusual for a small-cap stock, since they generally have a harder time borrowing than large more established companies. We can check to see whether ROOT is able to meet its debt obligations by looking at the net interest coverage ratio. A company generating earnings before interest and tax (EBIT) at least three times its net interest payments is considered financially sound. In ROOT’s, case, the ratio of 4.99x suggests that interest is appropriately covered, which means that lenders may be willing to lend out more funding as ROOT’s high interest coverage is seen as responsible and safe practice.

Next Steps:

ROOT’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. I admit this is a fairly basic analysis for ROOT’s financial health. Other important fundamentals need to be considered alongside. I recommend you continue to research Roots to get a better picture of the small-cap by looking at:

  1. Valuation: What is ROOT 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 ROOT is currently mispriced by the market.
  2. Historical Performance: What has ROOT’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.

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.