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While small-cap stocks, such as DNO ASA (OB:DNO) with its market cap of øre21b, 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, as mismanagement of capital can lead to bankruptcies, which occur at a higher rate for small-caps. Let's work through some financial health checks you may wish to consider if you're interested in this stock. However, potential investors would need to take a closer look, and I suggest you dig deeper yourself into DNO here.
Does DNO Produce Much Cash Relative To Its Debt?
DNO's debt levels surged from US$390m to US$594m over the last 12 months , which accounts for long term debt. With this growth in debt, the current cash and short-term investment levels stands at US$729m to keep the business going. Moreover, DNO has produced cash from operations of US$471m in the last twelve months, leading to an operating cash to total debt ratio of 79%, signalling that DNO’s operating cash is sufficient to cover its debt.
Does DNO’s liquid assets cover its short-term commitments?
With current liabilities at US$143m, it appears that the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 6.84x. The current ratio is calculated by dividing current assets by current liabilities. However, a ratio above 3x may be considered excessive by some investors, yet this is not usually a major negative for a company.
Can DNO service its debt comfortably?
With a debt-to-equity ratio of 49%, DNO 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 test if DNO’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 DNO, the ratio of 10.31x suggests that interest is comfortably covered, which means that lenders may be willing to lend out more funding as DNO’s high interest coverage is seen as responsible and safe practice.
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DNO’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 DNO'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 DNO has been performing in the past. You should continue to research DNO to get a more holistic view of the small-cap by looking at: