Investors are always looking for growth in small-cap stocks like Sprouts Farmers Market, Inc. (NASDAQ:SFM), with a market cap of US$2.6b. However, an important fact which most ignore is: how financially healthy is the business? Assessing first and foremost the financial health is crucial, since poor capital management may bring about 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 SFM here.
Does SFM Produce Much Cash Relative To Its Debt?
SFM has built up its total debt levels in the last twelve months, from US$483m to US$580m – this includes long-term debt. With this rise in debt, SFM currently has US$1.6m remaining in cash and short-term investments to keep the business going. Moreover, SFM has produced US$294m in operating cash flow during the same period of time, leading to an operating cash to total debt ratio of 51%, meaning that SFM’s current level of operating cash is high enough to cover debt.
Does SFM’s liquid assets cover its short-term commitments?
Looking at SFM’s US$310m in current liabilities, the company has been able to meet these commitments with a current assets level of US$334m, leading to a 1.08x current account ratio. The current ratio is the number you get when you divide current assets by current liabilities. Generally, for Consumer Retailing companies, this is a reasonable ratio as there’s enough of a cash buffer without holding too much capital in low return investments.
Can SFM service its debt comfortably?
SFM is a relatively highly levered company with a debt-to-equity of 98%. 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 SFM’s case, the ratio of 8.55x suggests that interest is appropriately covered, which means that debtors may be willing to loan the company more money, giving SFM ample headroom to grow its debt facilities.
SFM’s high cash coverage means that, although its debt levels are high, the company is able to utilise its borrowings efficiently in order to generate cash flow. Since there is also no concerns around SFM’s liquidity needs, this may be its optimal capital structure for the time being. This is only a rough assessment of financial health, and I’m sure SFM has company-specific issues impacting its capital structure decisions. I recommend you continue to research Sprouts Farmers Market to get a better picture of the small-cap by looking at:
- Future Outlook: What are well-informed industry analysts predicting for SFM’s future growth? Take a look at our free research report of analyst consensus for SFM’s outlook.
- Valuation: What is SFM 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 SFM 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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