While small-cap stocks, such as KMG Chemicals Inc (NYSE:KMG) with its market cap of US$888.98M, are popular for their explosive growth, investors should also be aware of their balance sheet to judge whether the company can survive a downturn. 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. However, given that I have not delve into the company-specifics, I suggest you dig deeper yourself into KMG here.
Does KMG generate an acceptable amount of cash through operations?
Over the past year, KMG has ramped up its debt from US$35.80M to US$526.27M – this includes both the current and long-term debt. With this increase in debt, the current cash and short-term investment levels stands at US$20.71M for investing into the business. Moreover, KMG has generated cash from operations of US$44.92M during the same period of time, leading to an operating cash to total debt ratio of 8.54%, meaning that KMG’s current level of operating cash is not high enough to cover debt. This ratio can also be interpreted as a measure of efficiency as an alternative to return on assets. In KMG’s case, it is able to generate 0.085x cash from its debt capital.
Can KMG pay its short-term liabilities?
At the current liabilities level of US$52.91M liabilities, the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 2.52x. Generally, for Chemicals companies, this is a reasonable ratio as there’s enough of a cash buffer without holding too capital in low return investments.
Is KMG’s debt level acceptable?
KMG is a relatively highly levered company with a debt-to-equity of 99.40%. This is not unusual for small-caps as debt tends to be a cheaper and faster source of funding for some businesses. We can test if KMG’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 KMG, the ratio of 4.62x suggests that interest is appropriately covered, which means that debtors may be willing to loan the company more money, giving KMG ample headroom to grow its debt facilities.
KMG’s cash flow coverage indicates it could improve its operating efficiency in order to meet demand for debt repayments should unforeseen events arise. Though, the company will be able to pay all of its upcoming liabilities from its current short-term assets. This is only a rough assessment of financial health, and I’m sure KMG has company-specific issues impacting its capital structure decisions. I recommend you continue to research KMG Chemicals to get a better picture of the stock by looking at:
- 1. Future Outlook: What are well-informed industry analysts predicting for KMG’s future growth? Take a look at our free research report of analyst consensus for KMG’s outlook.
- 2. Valuation: What is KMG 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 KMG 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.
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.