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Collins Foods Limited (ASX:CKF) is a small-cap stock with a market capitalization of AU$911m. 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? Understanding the company's financial health becomes vital, since poor capital management may bring about 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 just a partial view of the stock, and I’d encourage you to dig deeper yourself into CKF here.
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Does CKF Produce Much Cash Relative To Its Debt?
Over the past year, CKF has ramped up its debt from AU$212m to AU$289m , which accounts for long term debt. With this increase in debt, CKF currently has AU$63m remaining in cash and short-term investments , ready to be used for running the business. On top of this, CKF has produced cash from operations of AU$83m over the same time period, leading to an operating cash to total debt ratio of 29%, meaning that CKF’s current level of operating cash is high enough to cover debt.
Does CKF’s liquid assets cover its short-term commitments?
Looking at CKF’s AU$88m in current liabilities, the company may not have an easy time meeting these commitments with a current assets level of AU$78m, leading to a current ratio of 0.88x. The current ratio is the number you get when you divide current assets by current liabilities.
Can CKF service its debt comfortably?
CKF is a relatively highly levered company with a debt-to-equity of 84%. 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 CKF’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 CKF, the ratio of 6.96x suggests that interest is appropriately covered, which means that lenders may be inclined to lend more money to the company, as it is seen as safe in terms of payback.
Next Steps:
Although CKF’s debt level is towards the higher end of the spectrum, its cash flow coverage seems adequate to meet debt obligations which means its debt is being efficiently utilised. However, its low liquidity raises concerns over whether current asset management practices are properly implemented for the small-cap. This is only a rough assessment of financial health, and I'm sure CKF has company-specific issues impacting its capital structure decisions. I recommend you continue to research Collins Foods to get a better picture of the stock by looking at: