Are Meritage Homes Corporation's (NYSE:MTH) Interest Costs Too High?
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Investors are always looking for growth in small-cap stocks like Meritage Homes Corporation (NYSE:MTH), with a market cap of US$1.8b. However, an important fact which most ignore is: how financially healthy is the business? Assessing first and foremost the financial health is essential, as mismanagement of capital can lead to bankruptcies, which occur at a higher rate for small-caps. We'll look at some basic checks that can form a snapshot the company’s financial strength. However, this is just a partial view of the stock, and I suggest you dig deeper yourself into MTH here.
MTH’s Debt (And Cash Flows)
MTH's debt level has been constant at around US$1.3b over the previous year including long-term debt. At this constant level of debt, MTH currently has US$311m remaining in cash and short-term investments , ready to be used for running the business. Moreover, MTH has generated cash from operations of US$262m in the last twelve months, resulting in an operating cash to total debt ratio of 20%, indicating that MTH’s debt is appropriately covered by operating cash.
Can MTH pay its short-term liabilities?
With current liabilities at US$311m, the company has been able to meet these obligations given the level of current assets of US$3.2b, with a current ratio of 10.37x. The current ratio is calculated by dividing current assets by current liabilities. Having said that, a ratio above 3x may be considered excessive by some investors, yet this is not usually a major negative for a company.
Is MTH’s debt level acceptable?
With a debt-to-equity ratio of 76%, MTH 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 MTH’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 MTH, the ratio of 356x suggests that interest is comfortably covered, which means that lenders may be willing to lend out more funding as MTH’s high interest coverage is seen as responsible and safe practice.
Next Steps:
MTH’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. This may mean this is an optimal capital structure for the business, given that it is also meeting its short-term commitment. This is only a rough assessment of financial health, and I'm sure MTH has company-specific issues impacting its capital structure decisions. You should continue to research Meritage Homes to get a more holistic view of the small-cap by looking at:
Future Outlook: What are well-informed industry analysts predicting for MTH’s future growth? Take a look at our free research report of analyst consensus for MTH’s outlook.
Valuation: What is MTH 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 MTH 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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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.
