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While small-cap stocks, such as Northgate plc (LON:NTG) with its market cap of UK£431m, are popular for their explosive growth, investors should also be aware of their balance sheet to judge whether the company can survive a downturn. Evaluating financial health as part of your investment thesis is essential, as mismanagement of capital can lead to bankruptcies, which occur at a higher rate for small-caps. We’ll look at some basic checks that can form a snapshot the company’s financial strength. However, these checks don’t give you a full picture, so I recommend you dig deeper yourself into NTG here.
Does NTG Produce Much Cash Relative To Its Debt?
NTG has built up its total debt levels in the last twelve months, from UK£451m to UK£529m – this includes long-term debt. With this growth in debt, NTG’s cash and short-term investments stands at UK£48m to keep the business going. We note it produced negative cash flow over the last twelve months. For this article’s sake, I won’t be looking at this today, but you can take a look at some of NTG’s operating efficiency ratios such as ROA here.
Does NTG’s liquid assets cover its short-term commitments?
With current liabilities at UK£158m, it appears that the company may not be able to easily meet these obligations given the level of current assets of UK£158m, with a current ratio of 1x. The current ratio is the number you get when you divide current assets by current liabilities.
Does NTG face the risk of succumbing to its debt-load?
NTG is a relatively highly levered company with a debt-to-equity of 96%. This is somewhat unusual for small-caps companies, since lenders are often hesitant to provide attractive interest rates to less-established businesses. We can test if NTG’s debt levels are sustainable by measuring interest payments against earnings of a company. Ideally, earnings before interest and tax (EBIT) should cover net interest by at least three times. For NTG, the ratio of 4.78x suggests that interest is appropriately 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 NTG’s debt level is towards the higher end of the spectrum, its cash flow coverage seems adequate to meet debt obligations which means its debt is being efficiently utilised. However, its low liquidity raises concerns over whether current asset management practices are properly implemented for the small-cap. Keep in mind I haven’t considered other factors such as how NTG has been performing in the past. I suggest you continue to research Northgate to get a more holistic view of the stock by looking at:
- Future Outlook: What are well-informed industry analysts predicting for NTG’s future growth? Take a look at our free research report of analyst consensus for NTG’s outlook.
- Valuation: What is NTG 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 NTG is currently mispriced by the market.
- 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.