Investors are always looking for growth in small-cap stocks like Traffic Technologies Limited (ASX:TTI), with a market cap of AUD A$11.02M. However, an important fact which most ignore is: how financially healthy is the business? 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 TTI here.
How does TTI’s operating cash flow stack up against its debt?
TTI’s debt levels have fallen from A$24.6M to A$22.4M over the last 12 months , which is made up of current and long term debt. With this reduction in debt, TTI’s cash and short-term investments stands at A$0.7M for investing into the business. On top of this, TTI has produced A$3.6M in operating cash flow over the same time period, resulting in an operating cash to total debt ratio of 0.16x, meaning that TTI’s debt is not appropriately covered by operating cash. This ratio can also be a sign of operational efficiency as an alternative to return on assets. In TTI’s case, it is able to generate 0.16x cash from its debt capital.
Can TTI meet its short-term obligations with the cash in hand?
With current liabilities at A$17.7M liabilities, it appears that the company has been able to meet these obligations given the level of current assets of A$24.1M, with a current ratio of 1.36x. Usually, for transportation infrastructure companies, this is a suitable ratio since there’s sufficient cash cushion without leaving too much capital idle or in low-earning investments.
Does TTI face the risk of succumbing to its debt-load?
TTI 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 test if TTI’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 TTI, the ratio of 2.04x 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:
Are you a shareholder? At its current level of cash flow coverage, TTI has room for improvement to better cushion for events which may require debt repayment. However, its high liquidity ensures the company will continue to operate smoothly should unfavourable circumstances arise. Given that its financial position may change. I recommend keeping abreast of market expectations for TTI’s future growth on our free analysis platform.