Is ElringKlinger AG (FRA:ZIL2) A Financially Sound Company?

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Investors are always looking for growth in small-cap stocks like ElringKlinger AG (FRA:ZIL2), with a market cap of €361m. However, an important fact which most ignore is: how financially healthy is the business? Assessing first and foremost the financial health is vital, as mismanagement of capital can lead to bankruptcies, which occur at a higher rate for small-caps. Let’s work through some financial health checks you may wish to consider if you’re interested in this stock. Nevertheless, this is not a comprehensive overview, so I recommend you dig deeper yourself into ZIL2 here.

Does ZIL2 Produce Much Cash Relative To Its Debt?

Over the past year, ZIL2 has ramped up its debt from €673m to €859m , which accounts for long term debt. With this rise in debt, the current cash and short-term investment levels stands at €63m to keep the business going. Additionally, ZIL2 has produced €96m in operating cash flow in the last twelve months, resulting in an operating cash to total debt ratio of 11%, signalling that ZIL2’s operating cash is less than its debt.

Can ZIL2 pay its short-term liabilities?

At the current liabilities level of €478m, it seems that the business has been able to meet these commitments with a current assets level of €885m, leading to a 1.85x current account ratio. The current ratio is the number you get when you divide current assets by current liabilities. Usually, for Auto Components companies, this is a suitable ratio as there’s enough of a cash buffer without holding too much capital in low return investments.

DB:ZIL2 Historical Debt, May 29th 2019
DB:ZIL2 Historical Debt, May 29th 2019

Is ZIL2’s debt level acceptable?

With debt reaching 95% of equity, ZIL2 may be thought of as relatively highly levered. This is somewhat unusual for small-caps companies, since lenders are often hesitant to provide attractive interest rates to less-established businesses. We can check to see whether ZIL2 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 ZIL2’s, case, the ratio of 6.42x suggests that interest is appropriately covered, which means that lenders may be willing to lend out more funding as ZIL2’s high interest coverage is seen as responsible and safe practice.

Next Steps:

Although ZIL2’s debt level is towards the higher end of the spectrum, its cash flow coverage seems adequate to meet obligations which means its debt is being efficiently utilised. Since there is also no concerns around ZIL2’s liquidity needs, this may be its optimal capital structure for the time being. Keep in mind I haven’t considered other factors such as how ZIL2 has been performing in the past. You should continue to research ElringKlinger to get a more holistic view of the small-cap by looking at:

  1. Future Outlook: What are well-informed industry analysts predicting for ZIL2’s future growth? Take a look at our free research report of analyst consensus for ZIL2’s outlook.
  2. Valuation: What is ZIL2 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 ZIL2 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.

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.