Virtus Health Limited (ASX:VRT) is a small-cap stock with a market capitalization of AU$466.26M. 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? Companies operating in the Healthcare industry, even ones that are profitable, tend to be high risk. Evaluating financial health as part of your investment thesis is essential. Here are a few basic checks that are good enough to have a broad overview of the company’s financial strength. However, given that I have not delve into the company-specifics, I’d encourage you to dig deeper yourself into VRT here.
Does VRT generate an acceptable amount of cash through operations?
VRT has sustained its debt level by about AU$154.53M over the last 12 months – this includes both the current and long-term debt. At this current level of debt, the current cash and short-term investment levels stands at AU$27.34M for investing into the business. Moreover, VRT has generated AU$38.71M in operating cash flow during the same period of time, leading to an operating cash to total debt ratio of 25.05%, signalling that VRT’s current level of operating cash is high enough to cover debt. This ratio can also be interpreted as a measure of efficiency as an alternative to return on assets. In VRT’s case, it is able to generate 0.25x cash from its debt capital.
Does VRT’s liquid assets cover its short-term commitments?
Looking at VRT’s most recent AU$47.81M liabilities, it seems that the business has not been able to meet these commitments with a current assets level of AU$42.87M, leading to a 0.9x current account ratio. which is under the appropriate industry ratio of 3x.
Is VRT’s debt level acceptable?
VRT is a relatively highly levered company with a debt-to-equity of 53.40%. This is not uncommon for a small-cap company given that debt tends to be lower-cost and at times, more accessible. We can test if VRT’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 VRT, the ratio of 6.26x suggests that interest is appropriately covered, which means that lenders may be less hesitant to lend out more funding as VRT’s high interest coverage is seen as responsible and safe practice.
Next Steps:
VRT’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. But, its lack of liquidity raises questions over current asset management practices for the small-cap. Keep in mind I haven’t considered other factors such as how VRT has been performing in the past. I recommend you continue to research Virtus Health to get a better picture of the stock by looking at: