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While small-cap stocks, such as Watts Water Technologies, Inc. (NYSE:WTS) with its market cap of US$2.9b, are popular for their explosive growth, investors should also be aware of their balance sheet to judge whether the company can survive a downturn. 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. 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 suggest you dig deeper yourself into WTS here.
Does WTS Produce Much Cash Relative To Its Debt?
WTS's debt levels have fallen from US$447m to US$406m over the last 12 months , which also accounts for long term debt. With this reduction in debt, the current cash and short-term investment levels stands at US$170m , ready to be used for running the business. On top of this, WTS has generated US$171m in operating cash flow in the last twelve months, leading to an operating cash to total debt ratio of 42%, indicating that WTS’s current level of operating cash is high enough to cover debt.
Can WTS meet its short-term obligations with the cash in hand?
At the current liabilities level of US$322m, it appears that the company has been able to meet these commitments with a current assets level of US$730m, leading to a 2.27x current account ratio. The current ratio is the number you get when you divide current assets by current liabilities. Usually, for Machinery companies, this is a suitable ratio since there's a sufficient cash cushion without leaving too much capital idle or in low-earning investments.
Can WTS service its debt comfortably?
With a debt-to-equity ratio of 45%, WTS 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 check to see whether WTS 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 WTS's, case, the ratio of 12.98x suggests that interest is comfortably covered, which means that debtors may be willing to loan the company more money, giving WTS ample headroom to grow its debt facilities.
WTS’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 WTS's liquidity needs, this may be its optimal capital structure for the time being. I admit this is a fairly basic analysis for WTS's financial health. Other important fundamentals need to be considered alongside. I recommend you continue to research Watts Water Technologies to get a better picture of the small-cap by looking at:
- Future Outlook: What are well-informed industry analysts predicting for WTS’s future growth? Take a look at our free research report of analyst consensus for WTS’s outlook.
- Valuation: What is WTS 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 WTS 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.
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 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.