While small-cap stocks, such as Pacific Energy Limited (ASX:PEA) with its market cap of A$206.52M, are popular for their explosive growth, investors should also be aware of their balance sheet to judge whether the company can survive a downturn. So, understanding the company’s financial health becomes vital, 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 recommend you dig deeper yourself into PEA here.
Does PEA generate enough cash through operations?
PEA’s debt levels have fallen from A$42.1M to A$33.0M over the last 12 months , which is made up of current and long term debt. With this reduction in debt, the current cash and short-term investment levels stands at A$5.0M for investing into the business. Moreover, PEA has generated A$35.0M in operating cash flow during the same period of time, resulting in an operating cash to total debt ratio of 106.01%, indicating that PEA’s current level of operating cash is high enough to cover debt. This ratio can also be a sign of operational efficiency as an alternative to return on assets. In PEA’s case, it is able to generate 1.06x cash from its debt capital.
Can PEA pay its short-term liabilities?
At the current liabilities level of A$13.2M liabilities, the company has not maintained a sufficient level of current assets to meet its obligations, with the current ratio last standing at 0.96x, which is below the prudent industry ratio of 3x.
Can PEA service its debt comfortably?
PEA’s level of debt is appropriate relative to its total equity, at 22.76%. This range is considered safe as PEA is not taking on too much debt obligation, which can be restrictive and risky for equity-holders. We can check to see whether PEA is able to meet its debt obligations by looking at the net interest coverage ratio. A company generating earnings before interest and tax (EBIT) at least three times its net interest payments is considered financially sound. In PEA’s, case, the ratio of 14.82x suggests that interest is comfortably 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:
PEA’s debt level is appropriate for a company its size. Furthermore, it is able to generate sufficient cash flow coverage, meaning it is able to put its debt in good use. However, the company may struggle to meet its near term liabilities should an adverse event occur. I admit this is a fairly basic analysis for PEA’s financial health. Other important fundamentals need to be considered alongside. You should continue to research Pacific Energy to get a more holistic view of the stock by looking at: