Stokes Limited (ASX:SKS) is a small-cap stock with a market capitalization of AUD A$10.52M. 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? Given that SKS is not presently profitable, it’s crucial to evaluate the current state of its operations and pathway to profitability. I believe these basic checks tell most of the story you need to know. Nevertheless, I know these factors are very high-level, so I recommend you dig deeper yourself into SKS here.
Does SKS generate an acceptable amount of cash through operations?
SKS has built up its total debt levels in the last twelve months, from A$4M to A$6M – this includes both the current and long-term debt. With this growth in debt, SKS’s cash and short-term investments stands at A$2M , ready to deploy into the business. Though its trivial cash flows from operations make the cash-to-debt ratio less useful to us, though these low levels of cash means that operational efficiency is worth a look. As the purpose of this article is a high-level overview, I won’t be looking at this today, but you can assess some of SKS’s operating efficiency ratios such as ROA here.
Can SKS meet its short-term obligations with the cash in hand?
With current liabilities at A$9M liabilities, it appears that the company has been able to meet these commitments with a current assets level of A$11M, leading to a 1.27x current account ratio. Usually, for electrical equipment companies, this is a suitable ratio since there’s sufficient cash cushion without leaving too much capital idle or in low-earning investments.
Is SKS’s level of debt at an acceptable level?
SKS is a highly-leveraged company with debt exceeding equity by over 100%. This is not uncommon for a small-cap company given that debt tends to be lower-cost and at times, more accessible. But since SKS is currently loss-making, there’s a question of sustainability of its current operations. Maintaining a high level of debt, while revenues are still below costs, can be dangerous as liquidity tends to dry up in unexpected downturns.
Next Steps:
Are you a shareholder? At its current level of cash flow coverage, SKS has room for improvement to better cushion for events which may require debt repayment. Though, its high liquidity ensures the company will continue to operate smoothly should unfavourable circumstances arise. Given that its financial position may change. I suggest keeping on top of market expectations for SKS’s future growth on our free analysis platform.