Are Synlait Milk Limited’s (NZSE:SML) Interest Costs Too High?

Investors are always looking for growth in small-cap stocks like Synlait Milk Limited (NZSE:SML), with a market cap of NZ$1.96b. However, an important fact which most ignore is: how financially healthy is the business? Evaluating financial health as part of your investment thesis is vital, as mismanagement of capital can lead to bankruptcies, which occur at a higher rate for small-caps. Here are a few basic checks that are good enough to have a broad overview of the company’s financial strength. Nevertheless, since I only look at basic financial figures, I suggest you dig deeper yourself into SML here.

How much cash does SML generate through its operations?

Over the past year, SML has reduced its debt from NZ$215.45m to NZ$156.09m – this includes both the current and long-term debt. With this debt payback, the current cash and short-term investment levels stands at NZ$73.83m , ready to deploy into the business. Moreover, SML has generated cash from operations of NZ$115.18m in the last twelve months, resulting in an operating cash to total debt ratio of 73.79%, indicating that SML’s debt is appropriately covered by operating cash. This ratio can also be a sign of operational efficiency as an alternative to return on assets. In SML’s case, it is able to generate 0.74x cash from its debt capital.

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

At the current liabilities level of NZ$232.33m liabilities, the company has been able to meet these obligations given the level of current assets of NZ$258.49m, with a current ratio of 1.11x. For Food companies, this ratio is within a sensible range as there’s enough of a cash buffer without holding too capital in low return investments.

NZSE:SML Historical Debt June 20th 18
NZSE:SML Historical Debt June 20th 18

Does SML face the risk of succumbing to its debt-load?

With a debt-to-equity ratio of 31.88%, SML’s debt level may be seen as prudent. This range is considered safe as SML is not taking on too much debt obligation, which may be constraining for future growth. We can test if SML’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 SML, the ratio of 11.96x suggests that interest is comfortably covered, which means that debtors may be willing to loan the company more money, giving SML ample headroom to grow its debt facilities.

Next Steps:

SML’s debt level is appropriate for a company its size, and it is also able to generate sufficient cash flow coverage, meaning it has been able to put its debt in good use. In addition to this, the company will be able to pay all of its upcoming liabilities from its current short-term assets. I admit this is a fairly basic analysis for SML’s financial health. Other important fundamentals need to be considered alongside. I recommend you continue to research Synlait Milk to get a more holistic view of the stock by looking at:

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