Investors are always looking for growth in small-cap stocks like Action Construction Equipment Limited (NSE:ACE), with a market cap of ₹14.34b. However, an important fact which most ignore is: how financially healthy is the business? Evaluating financial health as part of your investment thesis is vital, since poor capital management may bring about bankruptcies, which occur at a higher rate for small-caps. I believe these basic checks tell most of the story you need to know. Nevertheless, since I only look at basic financial figures, I recommend you dig deeper yourself into ACE here.

Does ACE produce enough cash relative to debt?

ACE’s debt levels have fallen from ₹1.14b to ₹783.0m over the last 12 months , which comprises of short- and long-term debt. With this debt repayment, ACE’s cash and short-term investments stands at ₹419.6m for investing into the business. On top of this, ACE has generated ₹893.9m in operating cash flow in the last twelve months, leading to an operating cash to total debt ratio of 114%, indicating that ACE’s operating cash is sufficient to cover its debt. This ratio can also be interpreted as a measure of efficiency as an alternative to return on assets. In ACE’s case, it is able to generate 1.14x cash from its debt capital.

Can ACE meet its short-term obligations with the cash in hand?

With current liabilities at ₹3.50b, the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 1.13x. Generally, for Machinery 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.

Does ACE face the risk of succumbing to its debt-load?

ACE’s level of debt is appropriate relative to its total equity, at 20.5%. This range is considered safe as ACE is not taking on too much debt obligation, which may be constraining for future growth. We can check to see whether ACE is able to meet its debt obligations by looking at the net interest coverage ratio. A company generating earnings before interest and tax (EBIT) at least three times its net interest payments is considered financially sound. In ACE’s, case, the ratio of 8.42x suggests that interest is appropriately covered, which means that debtors may be willing to loan the company more money, giving ACE ample headroom to grow its debt facilities.

Next Steps:

ACE’s debt level is appropriate for a company its size, and it is also able to generate sufficient cash flow coverage, meaning it has been able to put its debt in good use. Furthermore, the company will be able to pay all of its upcoming liabilities from its current short-term assets. Keep in mind I haven’t considered other factors such as how ACE has been performing in the past. You should continue to research Action Construction Equipment to get a more holistic view of the stock by looking at: