Mid-caps stocks, like Reece Limited (ASX:REH) with a market capitalization of AUD $4.35B, aren’t the focus of most investors who prefer to direct their investments towards either large-cap or small-cap stocks. However, generally ignored mid-caps have historically delivered better risk-adjusted returns than the two other categories of stocks. I’ve put together a small checklist, which I believe provides a ballpark estimate of their financial health status. See our latest analysis for REH

Can REH service its debt comfortably?

While ideally the debt-to equity ratio of a financially healthy company should be less than 40%, several factors such as industry life-cycle and economic conditions can result in a company raising a significant amount of debt. REH’s debt-to-equity ratio stands at 8.63%, which indicates that the company faces low risk associated with debt. 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 at least three times its interest payments is considered financially sound. In REH’s case, its interest is excessively covered by its earnings as the ratio sits at 63.78x. Lenders may be less hesitant to lend out more funding as REH’s high interest coverage is seen as responsible and safe practice.

Can REH meet its short-term obligations with the cash in hand?

Another important aspect of financial health is liquidity: the company’s ability to meet short-term obligations, including payments to suppliers and employees. If an adverse event occurs, the company may be forced to pay these immediate expenses with its liquid assets. We need to assess REH’s cash and other liquid assets against its upcoming expenses. Our analysis shows that REH is unable to meet all of its upcoming commitments with its cash and other short-term assets. While this is not abnormal for companies, as their cash is better invested in the business or returned to investors than lying around, it does bring about some concerns should any unfavourable circumstances arise.

Next Steps:

Are you a shareholder? REH’s relatively safe debt levels is even more impressive due to its ability to generate high cash flow, which illustrates operating efficiency. Since REH’s financial situation could change over time, I encourage examining market expectations for REH’s future growth on our free analysis platform.

Are you a potential investor? Although investors should analyse the serviceability of debt, it shouldn’t be viewed in isolation of other factors. After all, debt financing is an important source of funding for companies seeking to grow through new projects and investments. REH’s Return on Capital Employed (ROCE) in order to see management’s track record at deploying funds in high-returning projects.

To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned.