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Southern Cross Media Group Limited (ASX:SXL) is a small-cap stock with a market capitalization of AU$777m. 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 crucial, since poor capital management may bring about bankruptcies, which occur at a higher rate for small-caps. Here are few basic financial health checks you should consider before taking the plunge. Nevertheless, this commentary is still very high-level, so I suggest you dig deeper yourself into SXL here.
How much cash does SXL generate through its operations?
Over the past year, SXL has maintained its debt levels at around AU$359m including long-term debt. At this stable level of debt, SXL currently has AU$56m remaining in cash and short-term investments for investing into the business. Moreover, SXL has produced AU$112m in operating cash flow during the same period of time, resulting in an operating cash to total debt ratio of 31%, signalling that SXL’s operating cash is sufficient to cover its debt. This ratio can also be a sign of operational efficiency as an alternative to return on assets. In SXL’s case, it is able to generate 0.31x cash from its debt capital.
Can SXL meet its short-term obligations with the cash in hand?
With current liabilities at AU$96m, it appears that the company has been able to meet these obligations given the level of current assets of AU$193m, with a current ratio of 2.01x. For Media companies, this ratio is within a sensible range as there’s enough of a cash buffer without holding too much capital in low return investments.
Does SXL face the risk of succumbing to its debt-load?
SXL is a relatively highly levered company with a debt-to-equity of 60%. This is not unusual for small-caps as debt tends to be a cheaper and faster source of funding for some businesses. We can check to see whether SXL 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 SXL’s, case, the ratio of 8.22x suggests that interest is appropriately covered, which means that lenders may be less hesitant to lend out more funding as SXL’s high interest coverage is seen as responsible and safe practice.
Next Steps:
Although SXL’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. Since there is also no concerns around SXL’s liquidity needs, this may be its optimal capital structure for the time being. This is only a rough assessment of financial health, and I’m sure SXL has company-specific issues impacting its capital structure decisions. I suggest you continue to research Southern Cross Media Group to get a more holistic view of the small-cap by looking at: