What does TalkTalk Telecom Group PLC's (LSE:TALK) Balance Sheet Tell Us Abouts Its Future?

While small-cap stocks, such as TalkTalk Telecom Group PLC (LSE:TALK) with its market cap of GBP £1.44B, are popular for their explosive growth, investors should also be aware of their balance sheet to judge whether the company can survive a downturn. Diversified Telecommunication Services businesses operating in the environment facing headwinds from current disruption, in particular ones that run negative earnings, are more likely to be higher risk. Evaluating financial health as part of your investment thesis is crucial. Here are a few basic checks that are good enough to have a broad overview of the company’s financial strength. However, this commentary is still very high-level, so I’d encourage you to dig deeper yourself into TALK here.

Does TALK generate enough cash through operations?

Over the past year, TALK has ramped up its debt from £709.0M to £871.0M , which is made up of current and long term debt. With this rise in debt, TALK's cash and short-term investments stands at £50.0M , ready to deploy into the business. Moreover, TALK has produced £232.0M in operating cash flow over the same time period, resulting in an operating cash to total debt ratio of 0.27x, meaning that TALK’s debt is not appropriately covered by operating cash. This ratio can also be a sign of operational efficiency for loss making businesses as traditional metrics such as return on asset (ROA) requires a positive net income. In TALK’s case, it is able to generate 0.27x cash from its debt capital.

Can TALK meet its short-term obligations with the cash in hand?

Looking at TALK’s most recent £538.0M liabilities, the company has not maintained a sufficient level of current assets to meet its obligations, with the current ratio last standing at 0.81x, which is below the prudent industry ratio of 3x.

Is TALK’s level of debt at an acceptable level?

TALK is a highly-leveraged company with debt exceeding equity by over 100%. This is not unusual for small-caps as debt tends to be a cheaper and faster source of funding for some businesses. Though, since TALK is presently loss-making, there’s a question of sustainability of its current operations. Running high debt, while not yet making money, can be risky in unexpected downturns as liquidity may dry up, making it hard to operate.

Next Steps:

Are you a shareholder? TALK’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. However, its low liquidity raises concerns over whether short term obligations can be met in time, and increasing debt funding to meet these needs could prove difficult. Moving forward, TALK's financial situation may change. I recommend keeping on top of market expectations for TALK's future growth on our free analysis platform.

Are you a potential investor? Investors shouldn't be put off by TALK's high debt levels based on this simple analysis. High level of cash generated from operating activities indicates its debt funding is being effectively used. However, the company may struggle to meet its near term liabilities should an adverse event occur. In order to build your confidence in the stock, you need to also examine the company's track record. I encourage you to continue your research by taking a look at TALK's past performance analysis on our free platform in order to determine for yourself whether its debt position is justified.

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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.