Are Rocca SA’s (WSE:RCA) Interest Costs Too High?

Investors are always looking for growth in small-cap stocks like Rocca SA (WSE:RCA), with a market cap of zł4.4m. However, an important fact which most ignore is: how financially healthy is the business? Understanding the company’s financial health becomes vital, as mismanagement of capital can lead to bankruptcies, which occur at a higher rate for small-caps. The following basic checks can help you get a picture of the company’s balance sheet strength. Nevertheless, these checks don’t give you a full picture, so I’d encourage you to dig deeper yourself into RCA here.

Does RCA Produce Much Cash Relative To Its Debt?

RCA has sustained its debt level by about zł683k over the last 12 months – this includes long-term debt. At this current level of debt, RCA currently has zł436k remaining in cash and short-term investments , ready to be used for running the business. Moreover, RCA has produced zł172k in operating cash flow during the same period of time, resulting in an operating cash to total debt ratio of 25%, meaning that RCA’s current level of operating cash is high enough to cover debt.

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

At the current liabilities level of zł642k, it appears that the company has been able to meet these commitments with a current assets level of zł865k, leading to a 1.35x current account ratio. The current ratio is the number you get when you divide current assets by current liabilities. Generally, for Basic Materials companies, this is a reasonable ratio since there is a bit of a cash buffer without leaving too much capital in a low-return environment.

WSE:RCA Historical Debt, March 20th 2019
WSE:RCA Historical Debt, March 20th 2019

Is RCA’s debt level acceptable?

With debt reaching 50% of equity, RCA may be thought of as relatively highly levered. This is a bit unusual for a small-cap stock, since they generally have a harder time borrowing than large more established companies. 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 RCA’s case, the ratio of 1.44x suggests that interest is not strongly covered, which means that lenders may refuse to lend the company more money, as it is seen as too risky in terms of default.

Next Steps:

Although RCA’s debt level is towards the higher end of the spectrum, its cash flow coverage seems adequate to meet obligations which means its debt is being efficiently utilised. Since there is also no concerns around RCA’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 RCA has been performing in the past. You should continue to research Rocca to get a better picture of the small-cap by looking at:

  1. Future Outlook: What are well-informed industry analysts predicting for RCA’s future growth? Take a look at our free research report of analyst consensus for RCA’s outlook.
  2. Historical Performance: What has RCA’s returns been like over the past? Go into more detail in the past track record analysis and take a look at the free visual representations of our analysis for more clarity.
  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.