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While small-cap stocks, such as Smart Metering Systems plc (LON:SMS) with its market cap of UK£605m, are popular for their explosive growth, investors should also be aware of their balance sheet to judge whether the company can survive a downturn. Evaluating financial health as part of your investment thesis is vital, as mismanagement of capital can lead to bankruptcies, which occur at a higher rate for small-caps. We'll look at some basic checks that can form a snapshot the company’s financial strength. Nevertheless, this is not a comprehensive overview, so I’d encourage you to dig deeper yourself into SMS here.
SMS’s Debt (And Cash Flows)
SMS has shrunk its total debt levels in the last twelve months, from UK£187m to UK£172m , which also accounts for long term debt. With this debt repayment, the current cash and short-term investment levels stands at UK£30m , ready to be used for running the business. Additionally, SMS has generated cash from operations of UK£40m in the last twelve months, resulting in an operating cash to total debt ratio of 23%, meaning that SMS’s operating cash is sufficient to cover its debt.
Does SMS’s liquid assets cover its short-term commitments?
At the current liabilities level of UK£211m, it seems that the business arguably has a rather low level of current assets relative its obligations, with the current ratio last standing at 0.36x. The current ratio is calculated by dividing current assets by current liabilities.
Is SMS’s debt level acceptable?
With debt reaching 76% of equity, SMS may be thought of as relatively highly levered. This is a bit unusual for a small-cap stock, since they generally have a harder time borrowing than large more established companies. We can test if SMS’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 SMS, the ratio of 6.1x suggests that interest is appropriately covered, which means that lenders may be inclined to lend more money to the company, as it is seen as safe in terms of payback.
Although SMS’s debt level is towards the higher end of the spectrum, its cash flow coverage seems adequate to meet debt obligations which means its debt is being efficiently utilised. However, its lack of liquidity raises questions over current asset management practices for the small-cap. Keep in mind I haven't considered other factors such as how SMS has been performing in the past. I recommend you continue to research Smart Metering Systems to get a more holistic view of the stock by looking at:
- Future Outlook: What are well-informed industry analysts predicting for SMS’s future growth? Take a look at our free research report of analyst consensus for SMS’s outlook.
- Valuation: What is SMS worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether SMS is currently mispriced by the market.
- Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at email@example.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.