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American States Water Company (NYSE:AWR) is a small-cap stock with a market capitalization of US$2.7b. 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? 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. The following basic checks can help you get a picture of the company's balance sheet strength. However, this is not a comprehensive overview, so I’d encourage you to dig deeper yourself into AWR here.
Does AWR Produce Much Cash Relative To Its Debt?
AWR's debt levels surged from US$390m to US$439m over the last 12 months , which accounts for long term debt. With this growth in debt, AWR's cash and short-term investments stands at US$1.8m , ready to be used for running the business. On top of this, AWR has produced cash from operations of US$130m over the same time period, resulting in an operating cash to total debt ratio of 30%, signalling that AWR’s operating cash is sufficient to cover its debt.
Does AWR’s liquid assets cover its short-term commitments?
With current liabilities at US$108m, the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 1.08x. The current ratio is calculated by dividing current assets by current liabilities. For Water Utilities 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.
Can AWR service its debt comfortably?
With debt reaching 78% of equity, AWR may be thought of as relatively highly levered. This is somewhat unusual for small-caps companies, since lenders are often hesitant to provide attractive interest rates to less-established businesses. We can check to see whether AWR is able to meet its debt obligations by looking at the net interest coverage ratio. A company generating earnings before interest and tax (EBIT) at least three times its net interest payments is considered financially sound. In AWR's, case, the ratio of 5.3x suggests that interest is appropriately covered, which means that lenders may be willing to lend out more funding as AWR’s high interest coverage is seen as responsible and safe practice.
AWR’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 AWR'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 AWR has company-specific issues impacting its capital structure decisions. I suggest you continue to research American States Water to get a more holistic view of the small-cap by looking at:
- Future Outlook: What are well-informed industry analysts predicting for AWR’s future growth? Take a look at our free research report of analyst consensus for AWR’s outlook.
- Historical Performance: What has AWR's returns been like over the past? Go into more detail in the past track record analysis and take a look at the free visual representations of our analysis for more clarity.
- 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 firstname.lastname@example.org. 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.