Collection House Limited (ASX:CLH) is a small-cap stock with a market capitalization of A$177.47M. 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? Evaluating financial health as part of your investment thesis is crucial, since poor capital management may bring about bankruptcies, which occur at a higher rate for small-caps. Here are few basic financial health checks you should consider before taking the plunge. However, given that I have not delve into the company-specifics, I suggest you dig deeper yourself into CLH here.
Does CLH generate enough cash through operations?
CLH has sustained its debt level by about A$123.4M over the last 12 months made up of current and long term debt. At this current level of debt, the current cash and short-term investment levels stands at A$48.5M for investing into the business. Additionally, CLH has generated cash from operations of A$62.0M in the last twelve months, leading to an operating cash to total debt ratio of 50.27%, meaning that CLH’s debt is appropriately covered by operating cash. This ratio can also be interpreted as a measure of efficiency as an alternative to return on assets. In CLH’s case, it is able to generate 0.5x cash from its debt capital.
Can CLH meet its short-term obligations with the cash in hand?
At the current liabilities level of A$17.3M liabilities, it appears that the company has been able to meet these commitments with a current assets level of A$60.9M, leading to a 3.53x current account ratio. Though, anything about 3x may be excessive, since CLH may be leaving too much capital in low-earning investments.
Does CLH face the risk of succumbing to its debt-load?
With debt reaching 65.41% of equity, CLH may be thought of as relatively highly levered. This is not unusual for small-caps as debt tends to be a cheaper and faster source of funding for some businesses. No matter how high the company’s debt, if it can easily cover the interest payments, it’s considered to be efficient with its use of excess leverage. A company generating earnings after interest and tax at least three times its net interest payments is considered financially sound. In CLH’s case, the ratio of 6.17x 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.
Next Steps:
Are you a shareholder? CLH’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 CLH’s liquidity needs, this may be its optimal capital structure for the time being. Going forward, its financial position may change. I recommend researching market expectations for CLH’s future growth on our free analysis platform.