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Aarti Drugs Limited (NSE:AARTIDRUGS) is a small-cap stock with a market capitalization of ₹12b. 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 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, this is not a comprehensive overview, so I suggest you dig deeper yourself into AARTIDRUGS here.
AARTIDRUGS’s Debt (And Cash Flows)
AARTIDRUGS has shrunk its total debt levels in the last twelve months, from ₹5.5b to ₹5.1b – this includes long-term debt. With this debt payback, AARTIDRUGS currently has ₹145m remaining in cash and short-term investments , ready to be used for running the business. Moreover, AARTIDRUGS has produced ₹1.4b in operating cash flow in the last twelve months, resulting in an operating cash to total debt ratio of 28%, meaning that AARTIDRUGS’s operating cash is sufficient to cover its debt.
Does AARTIDRUGS’s liquid assets cover its short-term commitments?
Looking at AARTIDRUGS’s ₹5.9b in current liabilities, the company has been able to meet these obligations given the level of current assets of ₹7.8b, with a current ratio of 1.33x. The current ratio is calculated by dividing current assets by current liabilities. Generally, for Pharmaceuticals companies, this is a reasonable ratio as there's enough of a cash buffer without holding too much capital in low return investments.
Is AARTIDRUGS’s debt level acceptable?
With a debt-to-equity ratio of 93%, AARTIDRUGS can be considered as an above-average leveraged company. This is somewhat unusual for small-caps companies, since lenders are often hesitant to provide attractive interest rates to less-established 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 before interest and tax (EBIT) at least three times its net interest payments is considered financially sound. In AARTIDRUGS's case, the ratio of 4.28x suggests that interest is appropriately covered, which means that debtors may be willing to loan the company more money, giving AARTIDRUGS ample headroom to grow its debt facilities.