Investors are always looking for growth in small-cap stocks like Advanced Drainage Systems Inc (NYSE:WMS), with a market cap of US$1.63b. However, an important fact which most ignore is: how financially healthy is the business? Evaluating financial health as part of your investment thesis is vital, since poor capital management may bring about bankruptcies, which occur at a higher rate for small-caps. Here are few basic financial health checks you should consider before taking the plunge. Nevertheless, given that I have not delve into the company-specifics, I recommend you dig deeper yourself into WMS here.
How does WMS’s operating cash flow stack up against its debt?
WMS has shrunken its total debt levels in the last twelve months, from US$428.80m to US$379.72m , which is made up of current and long term debt. With this reduction in debt, WMS currently has US$17.59m remaining in cash and short-term investments , ready to deploy into the business. On top of this, WMS has generated US$137.12m in operating cash flow in the last twelve months, leading to an operating cash to total debt ratio of 36.11%, signalling that WMS’s operating cash is sufficient to cover its debt. This ratio can also be interpreted as a measure of efficiency as an alternative to return on assets. In WMS’s case, it is able to generate 0.36x cash from its debt capital.
Does WMS’s liquid assets cover its short-term commitments?
Looking at WMS’s most recent US$221.24m liabilities, it appears that the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 2.07x. Usually, for Building companies, this is a suitable ratio since there’s sufficient cash cushion without leaving too much capital idle or in low-earning investments.
Can WMS service its debt comfortably?
With a debt-to-equity ratio of 60.85%, WMS can be considered as an above-average leveraged company. 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 WMS’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 WMS, the ratio of 8.57x suggests that interest is appropriately covered, which means that lenders may be less hesitant to lend out more funding as WMS’s high interest coverage is seen as responsible and safe practice.
WMS’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 WMS’s liquidity needs, this may be its optimal capital structure for the time being. Keep in mind I haven’t considered other factors such as how WMS has been performing in the past. I suggest you continue to research Advanced Drainage Systems to get a more holistic view of the small-cap by looking at:
- Future Outlook: What are well-informed industry analysts predicting for WMS’s future growth? Take a look at our free research report of analyst consensus for WMS’s outlook.
- Valuation: What is WMS worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether WMS is currently mispriced by the market.
- Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned.