Martinrea International Inc. (TSE:MRE) is a small-cap stock with a market capitalization of CA$1.1b. 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. However, this is just a partial view of the stock, and I’d encourage you to dig deeper yourself into MRE here.
MRE’s Debt (And Cash Flows)
Over the past year, MRE has ramped up its debt from CA$654m to CA$741m – this includes long-term debt. With this increase in debt, MRE currently has CA$70m remaining in cash and short-term investments , ready to be used for running the business. Additionally, MRE has produced CA$297m in operating cash flow during the same period of time, leading to an operating cash to total debt ratio of 40%, indicating that MRE’s current level of operating cash is high enough to cover debt.
Can MRE meet its short-term obligations with the cash in hand?
Looking at MRE’s CA$893m in current liabilities, the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 1.35x. The current ratio is calculated by dividing current assets by current liabilities. For Auto Components companies, this ratio is within a sensible range since there is a bit of a cash buffer without leaving too much capital in a low-return environment.
Is MRE’s debt level acceptable?
With a debt-to-equity ratio of 64%, MRE 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. We can test if MRE’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 MRE, the ratio of 10.4x suggests that interest is comfortably covered, which means that lenders may be willing to lend out more funding as MRE’s high interest coverage is seen as responsible and safe practice.
MRE’s high cash coverage means that, although its debt levels are high, the company is able to utilise its borrowings efficiently in order to generate cash flow. Since there is also no concerns around MRE's liquidity needs, this may be its optimal capital structure for the time being. Keep in mind I haven't considered other factors such as how MRE has been performing in the past. You should continue to research Martinrea International to get a more holistic view of the small-cap by looking at:
- Future Outlook: What are well-informed industry analysts predicting for MRE’s future growth? Take a look at our free research report of analyst consensus for MRE’s outlook.
- Valuation: What is MRE 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 MRE is currently mispriced by the market.
- 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.
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