Investors are always looking for growth in small-cap stocks like American Realty Investors, Inc. (NYSE:ARL), with a market cap of US$189m. However, an important fact which most ignore is: how financially healthy is the business? Understanding the company's financial health becomes essential, as mismanagement of capital can lead to bankruptcies, which occur at a higher rate for small-caps. We'll look at some basic checks that can form a snapshot the company’s financial strength. Nevertheless, this is not a comprehensive overview, so I suggest you dig deeper yourself into ARL here.
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ARL’s Debt (And Cash Flows)
Over the past year, ARL has reduced its debt from US$1.0b to US$445m , which also accounts for long term debt. With this debt payback, ARL currently has US$28m remaining in cash and short-term investments , ready to be used for running the business. Moving on, operating cash flow was negative over the last twelve months. For this article’s sake, I won’t be looking at this today, but you can examine some of ARL’s operating efficiency ratios such as ROA here.
Can ARL pay its short-term liabilities?
At the current liabilities level of US$15m, it seems that the business has been able to meet these obligations given the level of current assets of US$184m, with a current ratio of 12.47x. The current ratio is calculated by dividing current assets by current liabilities. However, a ratio greater than 3x may be considered by some to be quite high, however this is not necessarily a negative for the company.
Can ARL service its debt comfortably?
Since total debt levels exceed equity, ARL is a highly leveraged company. This is a bit unusual for a small-cap stock, since they generally have a harder time borrowing than large more established companies. 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 before interest and tax (EBIT) at least three times its net interest payments is considered financially sound. In ARL's case, the ratio of 0.2x suggests that interest is not strongly covered, which means that lenders may be more reluctant to lend out more funding as ARL’s low interest coverage already puts the company at higher risk of default.
ARL’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 ARL's liquidity needs, this may be its optimal capital structure for the time being. I admit this is a fairly basic analysis for ARL's financial health. Other important fundamentals need to be considered alongside. You should continue to research American Realty Investors to get a more holistic view of the small-cap by looking at:
- Historical Performance: What has ARL's returns been like over the past? Go into more detail in the past track record analysis and take a look at the free visual representations of our analysis for more clarity.
- 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.
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