Freedom Foods Group Limited (ASX:FNP) is a small-cap stock with a market capitalization of AU$1.25B. 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? 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. Nevertheless, this commentary is still very high-level, so I’d encourage you to dig deeper yourself into FNP here.
Does FNP generate enough cash through operations?
FNP has built up its total debt levels in the last twelve months, from AU$103.83M to AU$185.16M , which comprises of short- and long-term debt. With this rise in debt, FNP currently has AU$4.18M remaining in cash and short-term investments , ready to deploy into the business. Moreover, FNP has produced cash from operations of AU$5.38M during the same period of time, resulting in an operating cash to total debt ratio of 2.91%, indicating that FNP’s operating cash is not sufficient to cover its debt. This ratio can also be a sign of operational efficiency as an alternative to return on assets. In FNP’s case, it is able to generate 0.029x cash from its debt capital.
Can FNP pay its short-term liabilities?
At the current liabilities level of AU$243.40M liabilities, the company is not able to meet these obligations given the level of current assets of AU$135.59M, with a current ratio of 0.56x below the prudent level of 3x.
Does FNP face the risk of succumbing to its debt-load?
FNP is a relatively highly levered company with a debt-to-equity of 43.64%. This is not unusual for small-caps as debt tends to be a cheaper and faster source of funding for some businesses. No matter how high the company’s debt, if it can easily cover the interest payments, it’s considered to be efficient with its use of excess leverage. A company generating earnings after interest and tax at least three times its net interest payments is considered financially sound. In FNP’s case, the ratio of 2.87x suggests that interest is not strongly covered, which means that lenders may refuse to lend the company more money, as it is seen as too risky in terms of default.
Next Steps:
FNP’s cash flow coverage indicates it could improve its operating efficiency in order to meet demand for debt repayments should unforeseen events arise. In addition to this, 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 FNP has been performing in the past. You should continue to research Freedom Foods Group to get a more holistic view of the stock by looking at: