ARQ Group Limited (ASX:ARQ) is a small-cap stock with a market capitalization of AU$269m. 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? IT companies, even ones that are profitable, are more likely to be higher risk. So, understanding the company’s financial health becomes essential. Here are few basic financial health checks you should consider before taking the plunge. However, I know these factors are very high-level, so I suggest you dig deeper yourself into ARQ here.
Does ARQ produce enough cash relative to debt?
Over the past year, ARQ has ramped up its debt from AU$64m to AU$75m , which is made up of current and long term debt. With this growth in debt, ARQ’s cash and short-term investments stands at AU$15m , ready to deploy into the business. Moreover, ARQ has produced cash from operations of AU$25m in the last twelve months, resulting in an operating cash to total debt ratio of 34%, signalling that ARQ’s debt is appropriately covered by operating cash. This ratio can also be interpreted as a measure of efficiency as an alternative to return on assets. In ARQ’s case, it is able to generate 0.34x cash from its debt capital.
Can ARQ pay its short-term liabilities?
With current liabilities at AU$80m, it seems that the business may not have an easy time meeting these commitments with a current assets level of AU$61m, leading to a current ratio of 0.76x.
Can ARQ service its debt comfortably?
With debt reaching 45% of equity, ARQ may be thought of as relatively highly levered. This is not unusual for small-caps as debt tends to be a cheaper and faster source of funding for some businesses. We can test if ARQ’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 ARQ, the ratio of 8.27x suggests that interest is appropriately covered, which means that debtors may be willing to loan the company more money, giving ARQ ample headroom to grow its debt facilities.
Next Steps:
ARQ’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. But, its lack of liquidity raises questions over current asset management practices for the small-cap. Keep in mind I haven’t considered other factors such as how ARQ has been performing in the past. I recommend you continue to research ARQ Group to get a better picture of the stock by looking at: