Small-caps and large-caps are wildly popular among investors; however, mid-cap stocks, such as Holly Energy Partners LP (NYSE:HEP) with a market-capitalization of $3.31B, rarely draw their attention and few analysts cover them. Surprisingly though, when accounted for risk, mid-caps have delivered better returns compared to the two other categories of stocks. Mid-caps are found to be more volatile than the large-caps but safer than small-caps, largely due to their weaker balance sheet. I’ve put together a small checklist, which I believe provides a ballpark estimate of their financial health status. View our latest analysis for Holly Energy Partners
Can HEP service its debt comfortably?
A substantially higher debt poses a significant threat to a company’s profitability during a downturn. In the case of HEP, the debt-to-equity ratio is over 100%, which indicates that the company is holding a high level of debt relative to its net worth. In the event of financial turmoil, the company may experience difficulty meeting interest and other debt obligations. No matter how high the company’s debt, if it can easily cover the interest payments, it’s considered to be efficient with its use of excess leverage. A company generating earnings (EBIT) at least three times its interest payments is considered financially sound. In HEP’s case, its interest is excessively covered by its earnings as the ratio sits at 3.69x. Debtors may be willing to loan the company more money, giving HEP ample headroom to grow its debt facilities.
Can HEP meet its short-term obligations with the cash in hand?
Another important aspect of financial health is liquidity: the company’s ability to meet short-term obligations, including payments to suppliers and employees. If an adverse event occurs, the company may be forced to pay these immediate expenses with its liquid assets. We need to assess HEP’s cash and other liquid assets against its upcoming expenses. Our analysis shows that HEP 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.
Are you a shareholder? HEP’s high debt levels are not met with high cash flow coverage. This means investors should ask themselves if they think HEP can improve in terms of debt management and operational efficiency. Given that HEP’s capital structure may be different in the future, I encourage exploring market expectations for HEP’s future growth on our free analysis platform.
Are you a potential investor? While understanding the serviceability of debt is important when evaluating which companies are viable investments, it shouldn’t be the deciding factor. After all, debt financing is an important source of funding for companies seeking to grow through new projects and investments. HEP’s Return on Capital Employed (ROCE) in order to see management’s track record at deploying funds in high-returning projects.
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.