Switch, Inc. (NYSE:SWCH) is a small-cap stock with a market capitalization of US$2.6b. 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? 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, these checks don’t give you a full picture, so I recommend you dig deeper yourself into SWCH here.
Does SWCH Produce Much Cash Relative To Its Debt?
Over the past year, SWCH has maintained its debt levels at around US$606m including long-term debt. At this stable level of debt, SWCH’s cash and short-term investments stands at US$82m to keep the business going. Additionally, SWCH has produced cash from operations of US$178m in the last twelve months, resulting in an operating cash to total debt ratio of 29%, indicating that SWCH’s operating cash is sufficient to cover its debt.
Can SWCH meet its short-term obligations with the cash in hand?
Looking at SWCH’s US$75m in current 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 1.44x. The current ratio is calculated by dividing current assets by current liabilities. Usually, for IT companies, this is a suitable ratio since there is a bit of a cash buffer without leaving too much capital in a low-return environment.
Can SWCH service its debt comfortably?
SWCH is a relatively highly levered company with a debt-to-equity of 86%. This is somewhat unusual for small-caps companies, since lenders are often hesitant to provide attractive interest rates to less-established businesses. We can test if SWCH’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 SWCH, the ratio of 2.28x suggests that interest is not strongly covered, which means that lenders may be more reluctant to lend out more funding as SWCH’s low interest coverage already puts the company at higher risk of default.
SWCH’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. This may mean this is an optimal capital structure for the business, given that it is also meeting its short-term commitment. I admit this is a fairly basic analysis for SWCH’s financial health. Other important fundamentals need to be considered alongside. I suggest you continue to research Switch to get a more holistic view of the small-cap by looking at:
- Future Outlook: What are well-informed industry analysts predicting for SWCH’s future growth? Take a look at our free research report of analyst consensus for SWCH’s outlook.
- Valuation: What is SWCH 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 SWCH 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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