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While small-cap stocks, such as Collins Foods Limited (ASX:CKF) with its market cap of AU$613.78M, 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 crucial, as mismanagement of capital can lead to bankruptcies, which occur at a higher rate for small-caps. Here are few basic financial health checks you should consider before taking the plunge. However, since I only look at basic financial figures, I suggest you dig deeper yourself into CKF here.
Does CKF generate enough cash through operations?
CKF has built up its total debt levels in the last twelve months, from AU$168.67M to AU$186.48M – this includes both the current and long-term debt. With this increase in debt, the current cash and short-term investment levels stands at AU$104.75M , ready to deploy into the business. On top of this, CKF has produced cash from operations of AU$60.56M during the same period of time, resulting in an operating cash to total debt ratio of 32.48%, indicating that CKF’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 CKF’s case, it is able to generate 0.32x cash from its debt capital.
Does CKF’s liquid assets cover its short-term commitments?
With current liabilities at AU$73.58M, the company has been able to meet these obligations given the level of current assets of AU$114.07M, with a current ratio of 1.55x. Usually, for Hospitality companies, this is a suitable ratio since there’s sufficient cash cushion without leaving too much capital idle or in low-earning investments.
Is CKF’s debt level acceptable?
With a debt-to-equity ratio of 67.07%, CKF can be considered as an above-average leveraged company. 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 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 7.27x 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 obligations which means its debt is being efficiently utilised. 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 CKF’s financial health. Other important fundamentals need to be considered alongside. You should continue to research Collins Foods to get a better picture of the small-cap by looking at: