Pro-Pac Packaging Limited (ASX:PPG) is a small-cap stock with a market capitalization of AU$186m. 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 PPG is loss-making right now, it’s vital to understand 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 recommend you dig deeper yourself into PPG here.

Does PPG produce enough cash relative to debt?

Over the past year, PPG has ramped up its debt from AU$29m to AU$97m – this includes long-term debt. With this rise in debt, PPG’s cash and short-term investments stands at AU$3.2m for investing into the business. On top of this, PPG has generated cash from operations of AU$13m during the same period of time, resulting in an operating cash to total debt ratio of 13%, signalling that PPG’s debt is not appropriately covered by operating cash. This ratio can also be a sign of operational efficiency for loss making companies as traditional metrics such as return on asset (ROA) requires positive earnings. In PPG’s case, it is able to generate 0.13x cash from its debt capital.

Can PPG pay its short-term liabilities?

Looking at PPG’s AU$108m in current liabilities, it appears that the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 1.78x. Usually, for Packaging companies, this is a suitable ratio as there’s enough of a cash buffer without holding too much capital in low return investments.

Can PPG service its debt comfortably?

With debt reaching 44% of equity, PPG may be thought of as relatively highly levered. This is not unusual for small-caps as debt tends to be a cheaper and faster source of funding for some businesses. However, since PPG is presently loss-making, there’s a question of sustainability of its current operations. 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:

Although PPG’s debt level is towards the higher end of the spectrum, its cash flow coverage seems adequate to meet obligations which means its debt is being efficiently utilised. 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 PPG’s financial health. Other important fundamentals need to be considered alongside. I suggest you continue to research Pro-Pac Packaging to get a more holistic view of the small-cap by looking at: