While small-cap stocks, such as Forterra plc (LSE:FORT) with its market cap of £568.50M, 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 crucial, since poor capital management may bring about bankruptcies, which occur at a higher rate for small-caps. I believe these basic checks tell most of the story you need to know. Though, I know these factors are very high-level, so I suggest you dig deeper yourself into FORT here.
Does FORT generate enough cash through operations?
FORT has shrunken its total debt levels in the last twelve months, from £405.6M to £148.5M – this includes both the current and long-term debt. With this debt payback, FORT’s cash and short-term investments stands at £56.2M , ready to deploy into the business. Moreover, FORT has generated cash from operations of £37.5M during the same period of time, resulting in an operating cash to total debt ratio of 0.25x, meaning that FORT’s operating cash is sufficient to cover its debt. This ratio can also be interpreted as a measure of efficiency as an alternative to return on assets. In FORT’s case, it is able to generate 0.25x cash from its debt capital.
Does FORT’s liquid assets cover its short-term commitments?
With current liabilities at £72.4M liabilities, it seems that the business has been able to meet these obligations given the level of current assets of £126.8M, with a current ratio of 1.75x. Generally, for basic materials companies, this is a reasonable ratio since there is a bit of a cash buffer without leaving too much capital in a low-return environment.
Does FORT face the risk of succumbing to its debt-load?
FORT 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. We can test if FORT’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 FORT, the ratio of 12.02x suggests that interest is excessively covered, which means that debtors may be willing to loan the company more money, giving FORT ample headroom to grow its debt facilities.
Next Steps:
Are you a shareholder? FORT’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. This may mean this is an optimal capital structure for the business, given that it is also meeting its short-term commitment. Going forward, its financial position may be different. I suggest keeping abreast of market expectations for FORT’s future growth on our free analysis platform.