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Elementis plc (LON:ELM): Time For A Financial Health Check

Simply Wall St

Investors are always looking for growth in small-cap stocks like Elementis plc (LON:ELM), with a market cap of UK£952m. However, an important fact which most ignore is: how financially healthy is the business? Evaluating financial health as part of your investment thesis is 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, potential investors would need to take a closer look, and I suggest you dig deeper yourself into ELM here.

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Does ELM Produce Much Cash Relative To Its Debt?

ELM’s debt levels surged from US$346m to US$594m over the last 12 months , which accounts for long term debt. With this rise in debt, ELM’s cash and short-term investments stands at US$96m to keep the business going. On top of this, ELM has generated US$84m in operating cash flow during the same period of time, leading to an operating cash to total debt ratio of 14%, meaning that ELM’s operating cash is less than its debt.

Can ELM meet its short-term obligations with the cash in hand?

Looking at ELM’s US$168m in current liabilities, it appears that the company has been able to meet these obligations given the level of current assets of US$429m, with a current ratio of 2.56x. The current ratio is calculated by dividing current assets by current liabilities. Usually, for Chemicals companies, this is a suitable ratio as there’s enough of a cash buffer without holding too much capital in low return investments.

LSE:ELM Historical Debt, March 24th 2019

Is ELM’s debt level acceptable?

With a debt-to-equity ratio of 65%, ELM can be considered as an above-average 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. We can test if ELM’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 ELM, the ratio of 7.85x suggests that interest is appropriately covered, which means that lenders may be inclined to lend more money to the company, as it is seen as safe in terms of payback.

Next Steps:

ELM’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 ELM’s liquidity needs, this may be its optimal capital structure for the time being. This is only a rough assessment of financial health, and I’m sure ELM has company-specific issues impacting its capital structure decisions. You should continue to research Elementis to get a more holistic view of the small-cap by looking at:

  1. Future Outlook: What are well-informed industry analysts predicting for ELM’s future growth? Take a look at our free research report of analyst consensus for ELM’s outlook.
  2. Valuation: What is ELM 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 ELM is currently mispriced by the market.
  3. 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.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.