While small-cap stocks, such as Contact Energy Limited (NZSE:CEN) with its market cap of NZ$4.9b, 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 crucial, as mismanagement of capital can lead to bankruptcies, which occur at a higher rate for small-caps. Let’s work through some financial health checks you may wish to consider if you’re interested in this stock. Nevertheless, potential investors would need to take a closer look, and I’d encourage you to dig deeper yourself into CEN here.
Does CEN Produce Much Cash Relative To Its Debt?
CEN’s debt levels have fallen from NZ$1.6b to NZ$1.2b over the last 12 months , which also accounts for long term debt. With this reduction in debt, CEN’s cash and short-term investments stands at NZ$210m , ready to be used for running the business. Additionally, CEN has generated cash from operations of NZ$509m in the last twelve months, leading to an operating cash to total debt ratio of 42%, meaning that CEN’s operating cash is sufficient to cover its debt.
Does CEN’s liquid assets cover its short-term commitments?
At the current liabilities level of NZ$611m, it appears that the company may not have an easy time meeting these commitments with a current assets level of NZ$446m, leading to a current ratio of 0.73x. The current ratio is calculated by dividing current assets by current liabilities.
Is CEN’s debt level acceptable?
With debt reaching 42% of equity, CEN may be thought of as relatively highly levered. This is somewhat unusual for small-caps companies, since lenders are often hesitant to provide attractive interest rates to less-established businesses. No matter how high the company’s debt, if it can easily cover the interest payments, it’s considered to be efficient with its use of excess leverage. A company generating earnings before interest and tax (EBIT) at least three times its net interest payments is considered financially sound. In CEN’s case, the ratio of 3.74x suggests that interest is appropriately covered, which means that debtors may be willing to loan the company more money, giving CEN ample headroom to grow its debt facilities.
Although CEN’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. But, 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 CEN has been performing in the past. I recommend you continue to research Contact Energy to get a more holistic view of the stock by looking at:
- Future Outlook: What are well-informed industry analysts predicting for CEN’s future growth? Take a look at our free research report of analyst consensus for CEN’s outlook.
- Valuation: What is CEN 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 CEN 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.
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