ARC Document Solutions, Inc. (NYSE:ARC) is a small-cap stock with a market capitalization of US$105m. While investors primarily focus on the growth potential and competitive landscape of the small-cap companies, they end up ignoring a key aspect, which could be the biggest threat to its existence: its financial health. Why is it important? Understanding the company’s financial health becomes vital, since poor capital management may bring about 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, these checks don’t give you a full picture, so I suggest you dig deeper yourself into ARC here.
Does ARC Produce Much Cash Relative To Its Debt?
ARC’s debt levels have fallen from US$144m to US$127m over the last 12 months – this includes long-term debt. With this debt payback, the current cash and short-term investment levels stands at US$29m to keep the business going. On top of this, ARC has produced US$55m in operating cash flow during the same period of time, resulting in an operating cash to total debt ratio of 43%, meaning that ARC’s current level of operating cash is high enough to cover debt.
Can ARC meet its short-term obligations with the cash in hand?
With current liabilities at US$81m, it seems that the business has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 1.43x. The current ratio is the number you get when you divide current assets by current liabilities. Usually, for Commercial Services companies, this is a suitable ratio since there’s a sufficient cash cushion without leaving too much capital idle or in low-earning investments.
Can ARC service its debt comfortably?
ARC is a relatively highly levered company with a debt-to-equity of 86%. This is somewhat unusual for small-caps companies, since lenders are often hesitant to provide attractive interest rates to less-established businesses. We can check to see whether ARC 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 ARC’s, case, the ratio of 3.04x suggests that interest is appropriately covered, which means that lenders may be willing to lend out more funding as ARC’s high interest coverage is seen as responsible and safe practice.
ARC’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 ARC’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 ARC has been performing in the past. I suggest you continue to research ARC Document Solutions to get a more holistic view of the small-cap by looking at:
- Valuation: What is ARC 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 ARC is currently mispriced by the market.
- Historical Performance: What has ARC’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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