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While small-cap stocks, such as Aurelia Metals Limited (ASX:AMI) with its market cap of AU$410.82M, 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. However, this commentary is still very high-level, so I recommend you dig deeper yourself into AMI here.
How does AMI’s operating cash flow stack up against its debt?
Over the past year, AMI has reduced its debt from AU$113.35M to AU$105.65M , which is made up of current and long term debt. With this reduction in debt, the current cash and short-term investment levels stands at AU$34.86M for investing into the business. On top of this, AMI has produced AU$46.12M in operating cash flow in the last twelve months, leading to an operating cash to total debt ratio of 43.65%, meaning that AMI’s current level of operating cash is high enough to cover debt. This ratio can also be interpreted as a measure of efficiency as an alternative to return on assets. In AMI’s case, it is able to generate 0.44x cash from its debt capital.
Does AMI’s liquid assets cover its short-term commitments?
With current liabilities at AU$13.60M, it appears that the company has been able to meet these commitments with a current assets level of AU$46.48M, leading to a 3.42x current account ratio. Though, anything about 3x may be excessive, since AMI may be leaving too much capital in low-earning investments.
Does AMI face the risk of succumbing to its debt-load?
AMI 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 check to see whether AMI 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 AMI’s, case, the ratio of 5.98x suggests that interest is appropriately covered, which means that debtors may be willing to loan the company more money, giving AMI ample headroom to grow its debt facilities.
Next Steps:
Although AMI’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 AMI’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 AMI has been performing in the past. You should continue to research Aurelia Metals to get a more holistic view of the small-cap by looking at: