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Investors are always looking for growth in small-cap stocks like Seven Principles AG (ETR:T3T1), with a market cap of €40m. However, an important fact which most ignore is: how financially healthy is the business? Companies operating in the IT industry, even ones that are profitable, tend to be high risk. So, understanding the company’s financial health becomes essential. I believe these basic checks tell most of the story you need to know. Though, this commentary is still very high-level, so I recommend you dig deeper yourself into T3T1 here.
Does T3T1 produce enough cash relative to debt?
T3T1 has built up its total debt levels in the last twelve months, from €3m to €5m , which is mainly comprised of near term debt. With this increase in debt, T3T1 currently has €4m remaining in cash and short-term investments for investing into the business. Moreover, T3T1 has generated €4m in operating cash flow over the same time period, resulting in an operating cash to total debt ratio of 79%, indicating that T3T1’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 T3T1’s case, it is able to generate 0.79x cash from its debt capital.
Can T3T1 meet its short-term obligations with the cash in hand?
At the current liabilities level of €16m liabilities, it seems that the business has been able to meet these obligations given the level of current assets of €26m, with a current ratio of 1.6x. Generally, for IT companies, this is a reasonable ratio since there’s a sufficient cash cushion without leaving too much capital idle or in low-earning investments.
Can T3T1 service its debt comfortably?
T3T1 is a highly-leveraged company with debt exceeding equity by over 100%. This is not unusual for small-caps as debt tends to be a cheaper and faster source of funding for some businesses. We can test if T3T1’s debt levels are sustainable by measuring interest payments against earnings of a company. Ideally, earnings before interest and tax (EBIT) should cover net interest by at least three times. For T3T1, the ratio of 3.21x suggests that interest is appropriately covered, which means that debtors may be willing to loan the company more money, giving T3T1 ample headroom to grow its debt facilities.
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T3T1’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 T3T1’s liquidity needs, this may be its optimal capital structure for the time being. I admit this is a fairly basic analysis for T3T1’s financial health. Other important fundamentals need to be considered alongside. I recommend you continue to research Seven Principles to get a better picture of the small-cap by looking at: