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Are MTS Systems Corporation's (NASDAQ:MTSC) Interest Costs Too High?

Simply Wall St

MTS Systems Corporation (NASDAQ:MTSC) is a small-cap stock with a market capitalization of US$990m. 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 crucial, as mismanagement of capital can lead to bankruptcies, which occur at a higher rate for small-caps. Let's work through some financial health checks you may wish to consider if you're interested in this stock. However, potential investors would need to take a closer look, and I suggest you dig deeper yourself into MTSC here.

Does MTSC Produce Much Cash Relative To Its Debt?

MTSC's debt levels surged from US$442m to US$466m over the last 12 months – this includes long-term debt. With this increase in debt, MTSC's cash and short-term investments stands at US$75m to keep the business going. Moreover, MTSC has generated US$65m in operating cash flow in the last twelve months, resulting in an operating cash to total debt ratio of 14%, meaning that MTSC’s debt is not covered by operating cash.

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

Looking at MTSC’s US$257m in current liabilities, the company has been able to meet these obligations given the level of current assets of US$460m, with a current ratio of 1.79x. The current ratio is the number you get when you divide current assets by current liabilities. Generally, for Electronic companies, this is a reasonable ratio since there's a sufficient cash cushion without leaving too much capital idle or in low-earning investments.

NasdaqGS:MTSC Historical Debt, April 17th 2019

Is MTSC’s debt level acceptable?

With a debt-to-equity ratio of 98%, MTSC 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 MTSC’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 MTSC, the ratio of 2.86x suggests that interest is not strongly covered, which means that lenders may be more reluctant to lend out more funding as MTSC’s low interest coverage already puts the company at higher risk of default.

Next Steps:

Although MTSC’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. This may mean this is an optimal capital structure for the business, given that it is also meeting its short-term commitment. Keep in mind I haven't considered other factors such as how MTSC has been performing in the past. You should continue to research MTS Systems to get a more holistic view of the small-cap by looking at:

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