While small-cap stocks, such as Dechra Pharmaceuticals PLC (LON:DPH) with its market cap of UK£3.0b, are popular for their explosive growth, investors should also be aware of their balance sheet to judge whether the company can survive a downturn. Understanding the company's financial health becomes 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, potential investors would need to take a closer look, and I recommend you dig deeper yourself into DPH here.
Does DPH Produce Much Cash Relative To Its Debt?
DPH has built up its total debt levels in the last twelve months, from UK£175m to UK£317m , which accounts for long term debt. With this increase in debt, the current cash and short-term investment levels stands at UK£87m , ready to be used for running the business. Moreover, DPH has produced UK£81m in operating cash flow during the same period of time, leading to an operating cash to total debt ratio of 26%, meaning that DPH’s operating cash is sufficient to cover its debt.
Can DPH pay its short-term liabilities?
With current liabilities at UK£104m, it appears that the company has been able to meet these obligations given the level of current assets of UK£262m, with a current ratio of 2.51x. The current ratio is calculated by dividing current assets by current liabilities. Usually, for Pharmaceuticals companies, this is a suitable ratio since there's a sufficient cash cushion without leaving too much capital idle or in low-earning investments.
Does DPH face the risk of succumbing to its debt-load?
With a debt-to-equity ratio of 63%, DPH can be considered as an above-average leveraged company. 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 check to see whether DPH is able to meet its debt obligations by looking at the net interest coverage ratio. A company generating earnings before interest and tax (EBIT) at least three times its net interest payments is considered financially sound. In DPH's, case, the ratio of 3.87x suggests that interest is appropriately covered, which means that lenders may be willing to lend out more funding as DPH’s high interest coverage is seen as responsible and safe practice.
Although DPH’s debt level is towards the higher end of the spectrum, its cash flow coverage seems adequate to meet obligations which means its debt is being efficiently utilised. Since there is also no concerns around DPH's liquidity needs, this may be its optimal capital structure for the time being. I admit this is a fairly basic analysis for DPH's financial health. Other important fundamentals need to be considered alongside. I recommend you continue to research Dechra Pharmaceuticals to get a more holistic view of the small-cap by looking at:
- Future Outlook: What are well-informed industry analysts predicting for DPH’s future growth? Take a look at our free research report of analyst consensus for DPH’s outlook.
- Valuation: What is DPH 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 DPH 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.
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