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How Financially Strong Is Telford Homes Plc (LON:TEF)?

Simply Wall St

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Investors are always looking for growth in small-cap stocks like Telford Homes Plc (LON:TEF), with a market cap of UK£237m. However, an important fact which most ignore is: how financially healthy is the business? Assessing first and foremost the financial health is essential, as mismanagement of capital can lead to bankruptcies, which occur at a higher rate for small-caps. Let's work through some financial health checks you may wish to consider if you're interested in this stock. However, this is not a comprehensive overview, so I suggest you dig deeper yourself into TEF here.

Does TEF Produce Much Cash Relative To Its Debt?

TEF's debt levels have fallen from UK£113m to UK£106m over the last 12 months , which also accounts for long term debt. With this debt payback, TEF's cash and short-term investments stands at UK£32m , ready to be used for running the business. Moreover, TEF has generated UK£69m in operating cash flow over the same time period, resulting in an operating cash to total debt ratio of 65%, signalling that TEF’s debt is appropriately covered by operating cash.

Can TEF pay its short-term liabilities?

At the current liabilities level of UK£169m, it appears that the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 1.99x. The current ratio is calculated by dividing current assets by current liabilities. Usually, for Consumer Durables companies, this is a suitable ratio as there's enough of a cash buffer without holding too much capital in low return investments.

AIM:TEF Historical Debt, June 14th 2019

Can TEF service its debt comfortably?

TEF is a relatively highly levered company with a debt-to-equity of 42%. 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 TEF’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 TEF, the ratio of 62.4x suggests that interest is comfortably covered, which means that lenders may be willing to lend out more funding as TEF’s high interest coverage is seen as responsible and safe practice.

Next Steps:

Although TEF’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. Since there is also no concerns around TEF'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 TEF has been performing in the past. You should continue to research Telford Homes to get a better picture of the small-cap by looking at:

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