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What Investors Should Know About Micro Focus International plc's (LON:MCRO) Financial Strength

Simply Wall St

Micro Focus International plc (LON:MCRO), a large-cap worth UK£7.9b, comes to mind for investors seeking a strong and reliable stock investment. Risk-averse investors who are attracted to diversified streams of revenue and strong capital returns tend to seek out these large companies. However, the health of the financials determines whether the company continues to succeed. This article will examine Micro Focus International’s financial liquidity and debt levels to get an idea of whether the company can deal with cyclical downturns and maintain funds to accommodate strategic spending for future growth. Remember this is a very top-level look that focuses exclusively on financial health, so I recommend a deeper analysis into MCRO here.

View our latest analysis for Micro Focus International

Does MCRO Produce Much Cash Relative To Its Debt?

Over the past year, MCRO has maintained its debt levels at around US$4.9b – this includes long-term debt. At this constant level of debt, MCRO's cash and short-term investments stands at US$621m , ready to be used for running the business. Moreover, MCRO has produced cash from operations of US$615m during the same period of time, leading to an operating cash to total debt ratio of 13%, meaning that MCRO’s debt is not covered by operating cash.

Can MCRO meet its short-term obligations with the cash in hand?

Looking at MCRO’s US$2.4b in current liabilities, it seems that the business has been able to meet these obligations given the level of current assets of US$3.1b, with a current ratio of 1.25x. The current ratio is calculated by dividing current assets by current liabilities. Usually, for Software companies, this is a suitable ratio since there is a bit of a cash buffer without leaving too much capital in a low-return environment.

LSE:MCRO Historical Debt, April 10th 2019
LSE:MCRO Historical Debt, April 10th 2019

Is MCRO’s debt level acceptable?

With debt reaching 63% of equity, MCRO may be thought of as relatively highly levered. This is not unusual for large-caps since debt tends to be less expensive than equity because interest payments are tax deductible. Since large-caps are seen as safer than their smaller constituents, they tend to enjoy lower cost of capital. We can test if MCRO’s debt levels are sustainable by measuring interest payments against earnings of a company. Net interest should be covered by earnings before interest and tax (EBIT) by at least three times to be safe. For MCRO, the ratio of 2.69x suggests that interest is not strongly covered. Although it is highly unlikely we'd see Micro Focus International defaulting or announcing bankruptcy tomorrow, this situation may put the company in a tough position when borrowing more money in the future to fuel its growth.

Next Steps:

MCRO’s cash flow coverage indicates it could improve its operating efficiency in order to meet demand for debt repayments should unforeseen events arise. However, the company exhibits an ability to meet its near-term obligations, which isn't a big surprise for a large-cap. Keep in mind I haven't considered other factors such as how MCRO has been performing in the past. You should continue to research Micro Focus International to get a more holistic view of the stock by looking at:

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

  2. Valuation: What is MCRO 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 MCRO 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.