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Are Linamar Corporation's (TSE:LNR) Interest Costs Too High?

Simply Wall St

Linamar Corporation (TSE:LNR) is a small-cap stock with a market capitalization of CA$3.3b. 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, since poor capital management may bring about bankruptcies, which occur at a higher rate for small-caps. The following basic checks can help you get a picture of the company's balance sheet strength. Nevertheless, this is just a partial view of the stock, and I suggest you dig deeper yourself into LNR here.

Does LNR Produce Much Cash Relative To Its Debt?

LNR has built up its total debt levels in the last twelve months, from CA$1.3b to CA$2.5b , which accounts for long term debt. With this increase in debt, LNR currently has CA$472m remaining in cash and short-term investments , ready to be used for running the business. Additionally, LNR has produced CA$691m in operating cash flow during the same period of time, resulting in an operating cash to total debt ratio of 28%, indicating that LNR’s current level of operating cash is high enough to cover debt.

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

Looking at LNR’s CA$1.6b in current liabilities, it seems that the business has been able to meet these commitments with a current assets level of CA$3.2b, leading to a 2.01x current account ratio. The current ratio is the number you get when you divide current assets by current liabilities. For Auto Components companies, this ratio is within a sensible range as there's enough of a cash buffer without holding too much capital in low return investments.

TSX:LNR Historical Debt, April 24th 2019

Can LNR service its debt comfortably?

With a debt-to-equity ratio of 66%, LNR can be considered as an above-average leveraged company. This is somewhat unusual for small-caps companies, since lenders are often hesitant to provide attractive interest rates to less-established businesses. 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 before interest and tax (EBIT) at least three times its net interest payments is considered financially sound. In LNR's case, the ratio of 21.39x suggests that interest is comfortably covered, which means that lenders may be inclined to lend more money to the company, as it is seen as safe in terms of payback.

Next Steps:

Although LNR’s debt level is towards the higher end of the spectrum, its cash flow coverage seems adequate to meet obligations which means its debt is being efficiently utilised. Since there is also no concerns around LNR's liquidity needs, this may be its optimal capital structure for the time being. This is only a rough assessment of financial health, and I'm sure LNR has company-specific issues impacting its capital structure decisions. I recommend you continue to research Linamar to get a more holistic view of the small-cap by looking at:

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