You Might Like Fonterra Co-operative Group Limited (NZSE:FCG) But Do You Like Its Debt?

While small-cap stocks, such as Fonterra Co-operative Group Limited (NZSE:FCG) with its market cap of NZ$6.8b, 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, since poor capital management may bring about 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. Nevertheless, this is just a partial view of the stock, and I suggest you dig deeper yourself into FCG here.

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Does FCG Produce Much Cash Relative To Its Debt?

FCG has sustained its debt level by about NZ$7.8b over the last 12 months including long-term debt. At this constant level of debt, FCG's cash and short-term investments stands at NZ$348m , ready to be used for running the business. Moreover, FCG has produced NZ$1.2b in operating cash flow during the same period of time, leading to an operating cash to total debt ratio of 16%, signalling that FCG’s current level of operating cash is not high enough to cover debt.

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

At the current liabilities level of NZ$5.8b, it seems that the business has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 1.39x. The current ratio is the number you get when you divide current assets by current liabilities. For Food companies, this ratio is within a sensible range as there's enough of a cash buffer without holding too much capital in low return investments.

Can FCG service its debt comfortably?

With total debt exceeding equity, FCG is considered a highly levered company. This is a bit unusual for a small-cap stock, since they generally have a harder time borrowing than large more established companies. We can check to see whether FCG is able to meet its debt obligations by looking at the net interest coverage ratio. A company generating earnings before interest and tax (EBIT) at least three times its net interest payments is considered financially sound. In FCG's, case, the ratio of 1.65x suggests that interest is not strongly covered, which means that debtors may be less inclined to loan the company more money, reducing its headroom for growth through debt.

Next Steps:

FCG’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 FCG'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 FCG has been performing in the past. I recommend you continue to research Fonterra Co-operative Group to get a better picture of the small-cap by looking at:

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

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.