Are Wavestone SA’s (EPA:WAVE) Interest Costs Too High?

Wavestone SA (EPA:WAVE) is a small-cap stock with a market capitalization of €611m. 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? Companies operating in the IT industry, even ones that are profitable, tend to be high risk. Assessing first and foremost the financial health is vital. I believe these basic checks tell most of the story you need to know. However, I know these factors are very high-level, so I suggest you dig deeper yourself into WAVE here.

Does WAVE produce enough cash relative to debt?

Over the past year, WAVE has reduced its debt from €95m to €87m – this includes both the current and long-term debt. With this debt payback, WAVE currently has €52m remaining in cash and short-term investments for investing into the business. On top of this, WAVE has generated cash from operations of €30m during the same period of time, leading to an operating cash to total debt ratio of 35%, signalling that WAVE’s current level of operating cash is high enough to cover debt. This ratio can also be a sign of operational efficiency as an alternative to return on assets. In WAVE’s case, it is able to generate 0.35x cash from its debt capital.

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

Looking at WAVE’s most recent €147m liabilities, it seems that the business has been able to meet these obligations given the level of current assets of €204m, with a current ratio of 1.39x. Usually, for IT companies, this is a suitable ratio since there’s a sufficient cash cushion without leaving too much capital idle or in low-earning investments.

ENXTPA:WAVE Historical Debt November 8th 18
ENXTPA:WAVE Historical Debt November 8th 18

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

With a debt-to-equity ratio of 67%, WAVE 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 WAVE’s case, the ratio of 25.56x suggests that interest is comfortably covered, which means that lenders may be inclined to lend more money to the company, as it is seen as safe in terms of payback.

Next Steps:

Although WAVE’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 WAVE’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 WAVE has been performing in the past. I recommend you continue to research Wavestone to get a more holistic view of the small-cap by looking at:

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