While small-cap stocks, such as Gulf & Pacific Equities Corp (TSXV:GUF) with its market cap of CAD CA$5.32M, are popular for their explosive growth, investors should also be aware of their balance sheet to judge whether the company can survive a downturn. The significance of doing due diligence on a company’s financial strength stems from the fact that over 20,000 companies go bankrupt in every quarter in the US alone. These factors make a basic understanding of a company’s financial position of utmost importance for a potential investor. Here are a few basic checks that are good enough to have a broad overview of the company’s financial strength. See our latest analysis for GUF
Does GUF generate enough cash through operations?
Unxpected adverse events, such as natural disasters and wars, can be a true test of a company’s capacity to meet its obligations. Furthermore, failure to service debt can hurt its reputation, making funding expensive in the future. Can GUF pay off what it owes to its debtholder by using only cash from its operational activities? In the case of GUF, operating cash flow turned out to be 0.06x its debt level over the past twelve months. This means what GUF can generate on an annual basis only covers less than a tenth of what it actually owes its debtors in the near term, which raises a red flag.
Can GUF pay its short-term liabilities?
What about its commitments to other stakeholders such as payments to suppliers and employees? In times of adverse events, GUF may need to liquidate its short-term assets to pay these immediate obligations. We test for GUF’s ability to meet these needs by comparing its cash and short-term investments with current liabilities. Our analysis shows that GUF is able to meet its upcoming commitments with its cash and other short-term assets, which lessens our concerns for the company’s business operations should any unfavourable circumstances arise.
Can GUF service its debt comfortably?
Debt-to-equity ratio tells us how much of the asset debtors could claim if the company went out of business. In the case of GUF, the debt-to-equity ratio is over 100%, which means that it is a highly leveraged company. This is not a problem if the company has consistently grown its profits. But during a business downturn, as liquidity may dry up, making it hard to operate. We can test if GUF’s debt levels are sustainable by measuring interest payments against earnings of a company. Ideally, earnings should cover interest by at least three times, therefore reducing concerns when profit is highly volatile. GUF’s interest on debt is not strongly covered by earnings as it sits at around 1.42x. This means lenders may refuse to lend the company more money, as it is seen as too risky in terms of default.
Are you a shareholder? With a high level of debt on its balance sheet, GUF could still be in a financially strong position if its cash flow also stacked up. However, this isn’t the case, and there’s room for GUF to increase its operational efficiency. In addition to this, the company may struggle to meet its near term liabilities should an adverse event occur. Moving forward, GUF’s financial situation may change. I recommend researching market expectations for GUF’s future growth on our free analysis platform.
Are you a potential investor? GUF’s high debt levels on top of poor cash coverage in addition to low liquidity coverage of short-term obligations may send potential investors running the other way. But, keep in mind that this is a point-in-time analysis, and today’s performance may not be representative of GUF’s track record. I encourage you to continue your research by taking a look at GUF’s past performance analysis on our free platform to figure out GUF’s financial health position.
To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned.