Liberty Tax Inc (NASDAQ:TAX) is a small-cap stock with a market capitalization of $165.90M. 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, as mismanagement of capital can lead to 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, since I only look at basic financial figures, I’d encourage you to dig deeper yourself into TAX here.
Does TAX generate enough cash through operations?
Over the past year, TAX has ramped up its debt from $23.4M to $26.2M – this includes both the current and long-term debt. With this increase in debt, the current cash and short-term investment levels stands at $16.4M for investing into the business. Additionally, TAX has produced $32.4M in operating cash flow in the last twelve months, resulting in an operating cash to total debt ratio of 1.24x, meaning that TAX’s current level of operating cash is high enough to cover debt. This ratio can also be a sign of operational efficiency as an alternative to return on assets. In TAX’s case, it is able to generate 1.24x cash from its debt capital.
Can TAX pay its short-term liabilities?
Looking at TAX’s most recent $53.2M liabilities, it seems that the business has been able to meet these obligations given the level of current assets of $115.7M, with a current ratio of 2.18x. Usually, for consumer services companies, this is a suitable ratio as there’s enough of a cash buffer without holding too capital in low return investments.
Can TAX service its debt comfortably?
TAX is a relatively highly levered company with a debt-to-equity of 41.22%. 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 TAX’s case, the ratio of 12.7x suggests that interest is excessively 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? TAX’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 TAX’s liquidity needs, this may be its optimal capital structure for the time being. Moving forward, its financial position may change. I recommend keeping abreast of market expectations for TAX’s future growth on our free analysis platform.