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Investors are always looking for growth in small-cap stocks like Indian Metals and Ferro Alloys Limited (NSE:IMFA), with a market cap of ₹6.8b. However, an important fact which most ignore is: how financially healthy is the business? Evaluating financial health as part of your investment thesis is essential, since poor capital management may bring about 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, given that I have not delve into the company-specifics, I suggest you dig deeper yourself into IMFA here.
How does IMFA’s operating cash flow stack up against its debt?
IMFA has shrunken its total debt levels in the last twelve months, from ₹9.1b to ₹8.2b , which also accounts for long term debt. With this reduction in debt, the current cash and short-term investment levels stands at ₹1.7b , ready to deploy into the business. Moreover, IMFA has produced cash from operations of ₹3.0b over the same time period, resulting in an operating cash to total debt ratio of 36%, signalling that IMFA’s operating cash is sufficient to cover its debt. This ratio can also be a sign of operational efficiency as an alternative to return on assets. In IMFA’s case, it is able to generate 0.36x cash from its debt capital.
Can IMFA pay its short-term liabilities?
Looking at IMFA’s ₹6.4b in current liabilities, it seems that the business has been able to meet these commitments with a current assets level of ₹8.9b, leading to a 1.4x current account ratio. Generally, for Metals and Mining companies, this is a reasonable ratio as there’s enough of a cash buffer without holding too much capital in low return investments.
Is IMFA’s debt level acceptable?
With a debt-to-equity ratio of 66%, IMFA 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 IMFA’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 IMFA, the ratio of 4.99x suggests that interest is appropriately covered, which means that lenders may be less hesitant to lend out more funding as IMFA’s high interest coverage is seen as responsible and safe practice.
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IMFA’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. 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 IMFA’s financial health. Other important fundamentals need to be considered alongside. I suggest you continue to research Indian Metals and Ferro Alloys to get a more holistic view of the small-cap by looking at: