Gear4music (Holdings) plc (LON:G4M) is a small-cap stock with a market capitalization of UK£109m. 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? Specialty Retail businesses operating in the environment facing headwinds from current disruption, even ones that are profitable, are more likely to be higher risk. Evaluating financial health as part of your investment thesis is essential. 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 G4M here.
How much cash does G4M generate through its operations?
G4M’s debt levels surged from UK£7.8m to UK£10m over the last 12 months – this includes long-term debt. With this growth in debt, the current cash and short-term investment levels stands at UK£2.7m , ready to deploy into the business. However, G4M is only generating cash from operations of UK£20k over the same time period, leading to an operating cash to total debt ratio of under 1x, signalling that its operating cash is not sufficient to cover its debt. This ratio can also be a sign of operational efficiency as an alternative to return on assets. In G4M’s case, it generates less than 1x cash from its debt capital.
Can G4M meet its short-term obligations with the cash in hand?
At the current liabilities level of UK£21m, the company has been able to meet these obligations given the level of current assets of UK£28m, with a current ratio of 1.34x. 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.
Is G4M’s debt level acceptable?
With a debt-to-equity ratio of 55%, G4M can be considered as an above-average leveraged company. This is not uncommon for a small-cap company given that debt tends to be lower-cost and at times, more accessible. 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 G4M’s case, the ratio of 6.54x suggests that interest is appropriately covered, which means that lenders may be less hesitant to lend out more funding as G4M’s high interest coverage is seen as responsible and safe practice.
G4M’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. Keep in mind I haven’t considered other factors such as how G4M has been performing in the past. I recommend you continue to research Gear4music (Holdings) to get a more holistic view of the small-cap by looking at:
- Future Outlook: What are well-informed industry analysts predicting for G4M’s future growth? Take a look at our free research report of analyst consensus for G4M’s outlook.
- Historical Performance: What has G4M’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.
- 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 email@example.com.