Empire Resources Limited (ASX:ERL) is a small-cap stock with a market capitalization of AU$7.73M. 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? Since ERL is loss-making right now, it’s crucial to evaluate the current state of its operations and pathway to profitability. 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 ERL here.
How does ERL’s operating cash flow stack up against its debt?
Over the past year, ERL has ramped up its debt from AU$132.94K to AU$1.28M . With this growth in debt, ERL’s cash and short-term investments stands at AU$405.45K , ready to deploy into the business. Moving onto cash from operations, its small level of operating cash flow means calculating cash-to-debt wouldn’t be too useful, though these low levels of cash means that operational efficiency is worth a look. As the purpose of this article is a high-level overview, I won’t be looking at this today, but you can examine some of ERL’s operating efficiency ratios such as ROA here.
Does ERL’s liquid assets cover its short-term commitments?
At the current liabilities level of AU$4.28M liabilities, it appears that the company has not been able to meet these commitments with a current assets level of AU$1.73M, leading to a 0.41x current account ratio. which is under the appropriate industry ratio of 3x.
Does ERL face the risk of succumbing to its debt-load?
Since total debt levels have outpaced equities, ERL is a highly leveraged company. This is not unusual for small-caps as debt tends to be a cheaper and faster source of funding for some businesses. Though, since ERL is currently loss-making, sustainability of its current state of operations becomes a concern. Running high debt, while not yet making money, can be risky in unexpected downturns as liquidity may dry up, making it hard to operate.
Next Steps:
ERL’s high debt level indicates room for improvement. Furthermore, its cash flow coverage of less than a quarter of debt means that operating efficiency could also be an issue. In addition to this, its low liquidity raises concerns over whether current asset management practices are properly implemented for the small-cap. Keep in mind I haven’t considered other factors such as how ERL has been performing in the past. I recommend you continue to research Empire Resources to get a more holistic view of the stock by looking at the areas below. Just a heads up – to access some parts of the Simply Wall St research tool you might be asked to create a free account, but it takes just one click and the information they provide is definitely worth it in my opinion.