While small-cap stocks, such as Deepak Nitrite Limited (NSE:DEEPAKNI) with its market cap of ₹32b, are popular for their explosive growth, investors should also be aware of their balance sheet to judge whether the company can survive a downturn. Assessing first and foremost the financial health is crucial, since poor capital management may bring about bankruptcies, which occur at a higher rate for small-caps. Here are a few basic checks that are good enough to have a broad overview of the company’s financial strength. Though, given that I have not delve into the company-specifics, I recommend you dig deeper yourself into DEEPAKNI here.
Does DEEPAKNI produce enough cash relative to debt?
DEEPAKNI has built up its total debt levels in the last twelve months, from ₹7.2b to ₹9.9b , which includes long-term debt. With this growth in debt, DEEPAKNI’s cash and short-term investments stands at ₹693m for investing into the business. Moreover, DEEPAKNI has generated cash from operations of ₹1.8b over the same time period, resulting in an operating cash to total debt ratio of 19%, signalling that DEEPAKNI’s debt is not appropriately covered by operating cash. This ratio can also be interpreted as a measure of efficiency as an alternative to return on assets. In DEEPAKNI’s case, it is able to generate 0.19x cash from its debt capital.
Can DEEPAKNI meet its short-term obligations with the cash in hand?
With current liabilities at ₹10b, the company may not have an easy time meeting these commitments with a current assets level of ₹9.9b, leading to a current ratio of 0.95x.
Does DEEPAKNI face the risk of succumbing to its debt-load?
With total debt exceeding equities, DEEPAKNI is considered a highly levered company. This is not uncommon for a small-cap company given that debt tends to be lower-cost and at times, more accessible. 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 DEEPAKNI’s case, the ratio of 3.77x suggests that interest is appropriately covered, which means that debtors may be willing to loan the company more money, giving DEEPAKNI ample headroom to grow its debt facilities.
Next Steps:
Although DEEPAKNI’s debt level is towards the higher end of the spectrum, its cash flow coverage seems adequate to meet debt obligations which means its debt is being efficiently utilised. But, its low liquidity raises concerns over whether current asset management practices are properly implemented for the small-cap. Keep in mind I haven’t considered other factors such as how DEEPAKNI has been performing in the past. I suggest you continue to research Deepak Nitrite to get a more holistic view of the stock by looking at: