Investors are always looking for growth in small-cap stocks like South West Pinnacle Exploration Limited (NSE:SOUTHWEST), with a market cap of ₹614m. However, an important fact which most ignore is: how financially healthy is the business? Assessing first and foremost the financial health is vital, as mismanagement of capital can lead to 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, this commentary is still very high-level, so I’d encourage you to dig deeper yourself into SOUTHWEST here.
Does SOUTHWEST produce enough cash relative to debt?
Over the past year, SOUTHWEST has reduced its debt from ₹648m to ₹497m , which includes long-term debt. With this debt payback, SOUTHWEST currently has ₹29m remaining in cash and short-term investments for investing into the business. Moving onto cash from operations, its operating cash flow is not yet significant enough to calculate a meaningful cash-to-debt ratio, indicating that operational efficiency is something we’d need to take a look at. As the purpose of this article is a high-level overview, I won’t be looking at this today, but you can examine some of SOUTHWEST’s operating efficiency ratios such as ROA here.
Can SOUTHWEST meet its short-term obligations with the cash in hand?
Looking at SOUTHWEST’s ₹554m in current liabilities, the company has been able to meet these obligations given the level of current assets of ₹787m, with a current ratio of 1.42x. Usually, for Metals and Mining companies, this is a suitable ratio as there’s enough of a cash buffer without holding too much capital in low return investments.
Can SOUTHWEST service its debt comfortably?
With debt reaching 69% of equity, SOUTHWEST 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 check to see whether SOUTHWEST 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 SOUTHWEST’s, case, the ratio of 2.96x suggests that interest is not strongly covered, which means that debtors may be less inclined to loan the company more money, reducing its headroom for growth through debt.
Next Steps:
Although SOUTHWEST’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 SOUTHWEST’s liquidity needs, this may be its optimal capital structure for the time being. I admit this is a fairly basic analysis for SOUTHWEST’s financial health. Other important fundamentals need to be considered alongside. I recommend you continue to research South West Pinnacle Exploration to get a more holistic view of the small-cap by looking at: