Is Synlait Milk Limited's (NZE:SML) Balance Sheet A Threat To Its Future?

Synlait Milk Limited (NZSE:SML) is a small-cap stock with a market capitalization of NZ$1.75B. 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? 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. I believe these basic checks tell most of the story you need to know. However, I know these factors are very high-level, so I’d encourage you to dig deeper yourself into SML here.

Does SML generate enough cash through operations?

SML's debt levels have fallen from NZ$215.45M to NZ$156.09M over the last 12 months , which is made up of current and long term debt. With this reduction in debt, SML currently has NZ$73.83M remaining in cash and short-term investments for investing into the business. On top of this, SML has produced NZ$115.18M in operating cash flow during the same period of time, resulting in an operating cash to total debt ratio of 73.79%, signalling that SML’s debt is appropriately covered by operating cash. This ratio can also be interpreted as a measure of efficiency as an alternative to return on assets. In SML’s case, it is able to generate 0.74x cash from its debt capital.

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

Looking at SML’s most recent NZ$232.33M liabilities, it appears that the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 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.

Can SML service its debt comfortably?

With a debt-to-equity ratio of 31.88%, SML's debt level may be seen as prudent. SML is not taking on too much debt commitment, which can be restrictive and risky for equity-holders. We can check to see whether SML 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 SML's, case, 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. Furthermore, the company will be able to pay all of its upcoming liabilities from its current short-term assets. This is only a rough assessment of financial health, and I'm sure SML has company-specific issues impacting its capital structure decisions. You should 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.

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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.