Is SAF-Holland S.A.'s (FRA:SFQ) Balance Sheet A Threat To Its Future?

Simply Wall St

Sat, Jun 1, 2019, 1:45 AM

Investors are always looking for growth in small-cap stocks like SAF-Holland S.A. (FRA:SFQ), with a market cap of €429m. However, an important fact which most ignore is: how financially healthy is the business? Assessing first and foremost the financial health is essential, since poor capital management may bring about bankruptcies, which occur at a higher rate for small-caps. The following basic checks can help you get a picture of the company's balance sheet strength. However, these checks don't give you a full picture, so I suggest you dig deeper yourself into SFQ here.

SFQ’s Debt (And Cash Flows)

SFQ has shrunk its total debt levels in the last twelve months, from €445m to €386m – this includes long-term debt. With this debt repayment, the current cash and short-term investment levels stands at €138m , ready to be used for running the business. Additionally, SFQ has produced €72m in operating cash flow over the same time period, resulting in an operating cash to total debt ratio of 19%, indicating that SFQ’s debt is not covered by operating cash.

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

Looking at SFQ’s €223m in current liabilities, it seems that the business has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 2.49x. The current ratio is the number you get when you divide current assets by current liabilities. For Auto Components companies, this ratio is within a sensible range since there is a bit of a cash buffer without leaving too much capital in a low-return environment.

Can SFQ service its debt comfortably?

Since total debt levels exceed equity, SFQ is a highly leveraged company. This is somewhat unusual for small-caps companies, since lenders are often hesitant to provide attractive interest rates to less-established 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 before interest and tax (EBIT) at least three times its net interest payments is considered financially sound. In SFQ's case, the ratio of 9.52x suggests that interest is appropriately covered, which means that lenders may be willing to lend out more funding as SFQ’s high interest coverage is seen as responsible and safe practice.

Next Steps:

SFQ’s high cash coverage means that, although its debt levels are high, the company is able to utilise its borrowings efficiently in order to generate cash flow. Since there is also no concerns around SFQ's liquidity needs, this may be its optimal capital structure for the time being. Keep in mind I haven't considered other factors such as how SFQ has been performing in the past. I recommend you continue to research SAF-Holland to get a better picture of the small-cap by looking at: