Think Childcare Limited (ASX:TNK) is a small-cap stock with a market capitalization of AU$92m. 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? Evaluating financial health as part of your investment thesis is vital, as mismanagement of capital can lead to bankruptcies, which occur at a higher rate for small-caps. Here are a few basic checks that are good enough to have a broad overview of the company’s financial strength. Nevertheless, I know these factors are very high-level, so I’d encourage you to dig deeper yourself into TNK here.
Does TNK produce enough cash relative to debt?
Over the past year, TNK has ramped up its debt from AU$23m to AU$27m , which includes long-term debt. With this increase in debt, TNK’s cash and short-term investments stands at AU$3.6m for investing into the business. Moreover, TNK has produced cash from operations of AU$8.9m over the same time period, resulting in an operating cash to total debt ratio of 33%, meaning that TNK’s current level of operating cash is high enough to cover debt. This ratio can also be a sign of operational efficiency as an alternative to return on assets. In TNK’s case, it is able to generate 0.33x cash from its debt capital.
Can TNK pay its short-term liabilities?
With current liabilities at AU$12m, it appears that the company may not be able to easily meet these obligations given the level of current assets of AU$7.9m, with a current ratio of 0.66x.
Does TNK face the risk of succumbing to its debt-load?
With a debt-to-equity ratio of 69%, TNK can be considered as an above-average leveraged company. This is not uncommon for a small-cap company given that debt tends to be lower-cost and at times, more accessible. We can check to see whether TNK 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 TNK’s, case, the ratio of 4.69x suggests that interest is appropriately covered, which means that debtors may be willing to loan the company more money, giving TNK ample headroom to grow its debt facilities.
Although TNK’s debt level is towards the higher end of the spectrum, its cash flow coverage seems adequate to meet debt obligations which means its debt is being efficiently utilised. However, its low liquidity raises concerns over whether current asset management practices are properly implemented for the small-cap. This is only a rough assessment of financial health, and I’m sure TNK has company-specific issues impacting its capital structure decisions. I suggest you continue to research Think Childcare to get a more holistic view of the stock by looking at:
- Future Outlook: What are well-informed industry analysts predicting for TNK’s future growth? Take a look at our free research report of analyst consensus for TNK’s outlook.
- Valuation: What is TNK 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 TNK 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.
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