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While small-cap stocks, such as Dunelm Group plc (LON:DNLM) with its market cap of UK£1.9b, are popular for their explosive growth, investors should also be aware of their balance sheet to judge whether the company can survive a downturn. Assessing first and foremost the financial health is crucial, as mismanagement of capital can lead to bankruptcies, which occur at a higher rate for small-caps. The following basic checks can help you get a picture of the company's balance sheet strength. However, this is not a comprehensive overview, so I suggest you dig deeper yourself into DNLM here.
Does DNLM Produce Much Cash Relative To Its Debt?
DNLM's debt levels have fallen from UK£150m to UK£94m over the last 12 months , which includes long-term debt. With this debt repayment, the current cash and short-term investment levels stands at UK£21m , ready to be used for running the business. Moreover, DNLM has produced UK£146m in operating cash flow over the same time period, leading to an operating cash to total debt ratio of 155%, indicating that DNLM’s operating cash is sufficient to cover its debt.
Does DNLM’s liquid assets cover its short-term commitments?
With current liabilities at UK£141m, it seems that the business has been able to meet these obligations given the level of current assets of UK£207m, with a current ratio of 1.47x. The current ratio is the number you get when you divide current assets by current liabilities. Generally, for Specialty Retail companies, this is a reasonable ratio as there's enough of a cash buffer without holding too much capital in low return investments.
Can DNLM service its debt comfortably?
DNLM is a relatively highly levered company with a debt-to-equity of 61%. This is somewhat unusual for small-caps companies, since lenders are often hesitant to provide attractive interest rates to less-established businesses. We can test if DNLM’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 DNLM, the ratio of 53.59x suggests that interest is comfortably covered, which means that debtors may be willing to loan the company more money, giving DNLM ample headroom to grow its debt facilities.
Although DNLM’s debt level is towards the higher end of the spectrum, its cash flow coverage seems adequate to meet obligations which means its debt is being efficiently utilised. This may mean this is an optimal capital structure for the business, given that it is also meeting its short-term commitment. This is only a rough assessment of financial health, and I'm sure DNLM has company-specific issues impacting its capital structure decisions. I suggest you continue to research Dunelm Group to get a better picture of the small-cap by looking at:
- Future Outlook: What are well-informed industry analysts predicting for DNLM’s future growth? Take a look at our free research report of analyst consensus for DNLM’s outlook.
- Valuation: What is DNLM 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 DNLM 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.
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 firstname.lastname@example.org. 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.