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While small-cap stocks, such as Meghmani Organics Limited (NSE:MEGH) with its market cap of ₹14b, are popular for their explosive growth, investors should also be aware of their balance sheet to judge whether the company can survive a downturn. So, understanding the company’s financial health becomes essential, 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. Nevertheless, since I only look at basic financial figures, I recommend you dig deeper yourself into MEGH here.
How does MEGH’s operating cash flow stack up against its debt?
MEGH has built up its total debt levels in the last twelve months, from ₹4.5b to ₹6.4b – this includes long-term debt. With this increase in debt, the current cash and short-term investment levels stands at ₹1.5b for investing into the business. Moreover, MEGH has generated ₹4.6b in operating cash flow over the same time period, leading to an operating cash to total debt ratio of 72%, meaning that MEGH’s debt is appropriately covered by operating cash. This ratio can also be interpreted as a measure of efficiency as an alternative to return on assets. In MEGH’s case, it is able to generate 0.72x cash from its debt capital.
Can MEGH meet its short-term obligations with the cash in hand?
With current liabilities at ₹6.8b, the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 1.62x. For Chemicals companies, this ratio is within a sensible range since there is a bit of a cash buffer without leaving too much capital in a low-return environment.
Is MEGH’s debt level acceptable?
With debt reaching 63% of equity, MEGH may be thought of as relatively highly levered. This is not unusual for small-caps as debt tends to be a cheaper and faster source of funding for some businesses. We can test if MEGH’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 MEGH, the ratio of 10.93x suggests that interest is comfortably covered, which means that debtors may be willing to loan the company more money, giving MEGH ample headroom to grow its debt facilities.
Next Steps:
MEGH’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. This is only a rough assessment of financial health, and I’m sure MEGH has company-specific issues impacting its capital structure decisions. I recommend you continue to research Meghmani Organics to get a more holistic view of the small-cap by looking at: