Are XP Power Limited's (LON:XPP) Interest Costs Too High?
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XP Power Limited (LON:XPP) is a small-cap stock with a market capitalization of UK£464m. 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? Understanding the company's financial health becomes crucial, 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, these checks don't give you a full picture, so I suggest you dig deeper yourself into XPP here.
XPP’s Debt (And Cash Flows)
XPP's debt levels surged from UK£24m to UK£64m over the last 12 months , which accounts for long term debt. With this increase in debt, XPP currently has UK£12m remaining in cash and short-term investments , ready to be used for running the business. Moreover, XPP has produced cash from operations of UK£27m over the same time period, resulting in an operating cash to total debt ratio of 42%, signalling that XPP’s debt is appropriately covered by operating cash.
Can XPP meet its short-term obligations with the cash in hand?
With current liabilities at UK£27m, the company has been able to meet these commitments with a current assets level of UK£105m, leading to a 3.92x current account ratio. The current ratio is calculated by dividing current assets by current liabilities. However, a ratio above 3x may be considered excessive by some investors, yet this is not usually a major negative for a company.
Is XPP’s debt level acceptable?
XPP is a relatively highly levered company with a debt-to-equity of 46%. 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 XPP 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 XPP's, case, the ratio of 24.81x suggests that interest is comfortably covered, which means that debtors may be willing to loan the company more money, giving XPP ample headroom to grow its debt facilities.
Next Steps:
XPP’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. I admit this is a fairly basic analysis for XPP's financial health. Other important fundamentals need to be considered alongside. I recommend you continue to research XP Power to get a more holistic view of the small-cap by looking at:
Future Outlook: What are well-informed industry analysts predicting for XPP’s future growth? Take a look at our free research report of analyst consensus for XPP’s outlook.
Valuation: What is XPP 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 XPP 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.
