While small-cap stocks, such as Dignity plc (LSE:DTY) with its market cap of UK£437.15M, are popular for their explosive growth, investors should also be aware of their balance sheet to judge whether the company can survive a downturn. Evaluating financial health as part of your investment thesis is essential, as mismanagement of capital can lead to bankruptcies, which occur at a higher rate for small-caps. Here are a few basic checks that are good enough to have a broad overview of the company’s financial strength. Though, since I only look at basic financial figures, I suggest you dig deeper yourself into DTY here.
Does DTY generate enough cash through operations?
DTY has sustained its debt level by about UK£565.70M over the last 12 months made up of current and long term debt. At this constant level of debt, DTY’s cash and short-term investments stands at UK£49.30M for investing into the business. Additionally, DTY has generated cash from operations of UK£75.00M in the last twelve months, resulting in an operating cash to total debt ratio of 13.26%, meaning that DTY’s current level of operating cash is not high enough to cover debt. This ratio can also be interpreted as a measure of efficiency as an alternative to return on assets. In DTY’s case, it is able to generate 0.13x cash from its debt capital.
Can DTY pay its short-term liabilities?
At the current liabilities level of UK£70.00M liabilities, it appears that the company has been able to meet these commitments with a current assets level of UK£94.90M, leading to a 1.36x current account ratio. For Consumer Services companies, this ratio is within a sensible range as there’s enough of a cash buffer without holding too capital in low return investments.
Can DTY service its debt comfortably?
Since total debt levels have outpaced equities, DTY is a highly leveraged company. This is not uncommon for a small-cap company given that debt tends to be lower-cost and at times, more accessible. We can check to see whether DTY 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 DTY’s, case, the ratio of 3.73x 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:
DTY’s cash flow coverage indicates it could improve its operating efficiency in order to meet demand for debt repayments should unforeseen events arise. Though, the company exhibits an ability to meet its near term obligations should an adverse event occur. I admit this is a fairly basic analysis for DTY’s financial health. Other important fundamentals need to be considered alongside. You should continue to research Dignity to get a better picture of the stock by looking at: