Is Kratos Defense & Security Solutions, Inc.’s (NASDAQ:KTOS) Balance Sheet Strong Enough To Weather A Storm?

Kratos Defense & Security Solutions, Inc. (NASDAQ:KTOS) is a small-cap stock with a market capitalization of US$1.6b. 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? Assessing first and foremost the financial health 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, this is not a comprehensive overview, so I recommend you dig deeper yourself into KTOS here.

Does KTOS Produce Much Cash Relative To Its Debt?

KTOS’s debt level has been constant at around US$294m over the previous year including long-term debt. At this constant level of debt, KTOS currently has US$183m remaining in cash and short-term investments , ready to be used for running the business. Additionally, KTOS has generated cash from operations of US$10m over the same time period, resulting in an operating cash to total debt ratio of 3.5%, indicating that KTOS’s debt is not covered by operating cash.

Can KTOS pay its short-term liabilities?

Looking at KTOS’s US$165m in current liabilities, it seems that the business has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 3x. The current ratio is the number you get when you divide current assets by current liabilities. Having said that, many consider a ratio above 3x to be high, although this is not necessarily a bad thing.

NasdaqGS:KTOS Historical Debt, April 2nd 2019
NasdaqGS:KTOS Historical Debt, April 2nd 2019

Is KTOS’s debt level acceptable?

KTOS is a relatively highly levered company with a debt-to-equity of 57%. 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 test if KTOS’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 KTOS, the ratio of 1.65x 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 KTOS’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 KTOS’s liquidity needs, this may be its optimal capital structure for the time being. I admit this is a fairly basic analysis for KTOS’s financial health. Other important fundamentals need to be considered alongside. I suggest you continue to research Kratos Defense & Security Solutions to get a more holistic view of the small-cap by looking at:

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