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Are Thermal Energy International Inc.'s (CVE:TMG) Interest Costs Too High?

Simply Wall St

Thermal Energy International Inc. (CVE:TMG) is a small-cap stock with a market capitalization of CA$12m. 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, since poor capital management may bring about 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, these checks don't give you a full picture, so I’d encourage you to dig deeper yourself into TMG here.

Does TMG Produce Much Cash Relative To Its Debt?

In the previous 12 months, TMG's rose by about CA$3.0m – which includes long-term debt. With this increase in debt, TMG's cash and short-term investments stands at CA$2.2m to keep the business going. Moving on, operating cash flow was negative over the last twelve months. For this article’s sake, I won’t be looking at this today, but you can examine some of TMG’s operating efficiency ratios such as ROA here.

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

Looking at TMG’s CA$5.2m in current liabilities, it appears that the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 1.4x. The current ratio is the number you get when you divide current assets by current liabilities. For Machinery companies, this ratio is within a sensible range since there's a sufficient cash cushion without leaving too much capital idle or in low-earning investments.

TSXV:TMG Historical Debt, April 17th 2019

Is TMG’s debt level acceptable?

TMG is a relatively highly levered company with a debt-to-equity of 73%. This is a bit unusual for a small-cap stock, since they generally have a harder time borrowing than large more established companies. We can test if TMG’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 TMG, the ratio of 3.75x suggests that interest is appropriately covered, which means that lenders may be willing to lend out more funding as TMG’s high interest coverage is seen as responsible and safe practice.

Next Steps:

Although TMG’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 TMG'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 TMG has company-specific issues impacting its capital structure decisions. I suggest you continue to research Thermal Energy International to get a better picture of the small-cap by looking at:

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