Are The Character Group plc's (LON:CCT) Interest Costs Too High?

While small-cap stocks, such as The Character Group plc (LON:CCT) with its market cap of UK£113m, are popular for their explosive growth, investors should also be aware of their balance sheet to judge whether the company can survive a downturn. So, understanding the company's financial health becomes vital, since poor capital management may bring about bankruptcies, which occur at a higher rate for small-caps. Here are few basic financial health checks you should consider before taking the plunge. However, given that I have not delve into the company-specifics, I suggest you dig deeper yourself into CCT here.

How much cash does CCT generate through its operations?

Over the past year, CCT has ramped up its debt from UK£17m to UK£19m , which is mainly comprised of near term debt. With this growth in debt, CCT's cash and short-term investments stands at UK£35m , ready to deploy into the business. Moreover, CCT has produced UK£11m in operating cash flow during the same period of time, leading to an operating cash to total debt ratio of 56%, indicating that CCT’s debt is appropriately covered by operating cash. This ratio can also be interpreted as a measure of efficiency as an alternative to return on assets. In CCT’s case, it is able to generate 0.56x cash from its debt capital.

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

At the current liabilities level of UK£46m, it appears that the company has been able to meet these commitments with a current assets level of UK£71m, leading to a 1.56x current account ratio. Generally, for Leisure companies, this is a reasonable ratio since there is a bit of a cash buffer without leaving too much capital in a low-return environment.

Is CCT’s debt level acceptable?

CCT is a relatively highly levered company with a debt-to-equity of 60%. 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 CCT's case, the ratio of 507x suggests that interest is comfortably covered, which means that debtors may be willing to loan the company more money, giving CCT ample headroom to grow its debt facilities.

Next Steps:

CCT’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. Since there is also no concerns around CCT's liquidity needs, this may be its optimal capital structure for the time being. I admit this is a fairly basic analysis for CCT's financial health. Other important fundamentals need to be considered alongside. I recommend you continue to research Character Group to get a better picture of the small-cap by looking at:

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

Simply Wall St analyst Simply Wall St and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.