While small-cap stocks, such as Pacific Energy Limited ( ASX:PEA ) with its market cap of AU$264m, are popular for their explosive growth, investors should also be aware of their balance sheet to judge whether the company can survive a downturn. 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. We'll look at some basic checks that can form a snapshot the company’s financial strength. However, potential investors would need to take a closer look, and I suggest you dig deeper yourself into PEA here .
Want to participate in a short research study ? Help shape the future of investing tools and you could win a $250 gift card!
Does PEA Produce Much Cash Relative To Its Debt?
PEA's debt levels surged from AU$43m to AU$82m over the last 12 months – this includes long-term debt. With this growth in debt, PEA currently has AU$3.8m remaining in cash and short-term investments to keep the business going. On top of this, PEA has produced AU$46m in operating cash flow over the same time period, leading to an operating cash to total debt ratio of 56%, meaning that PEA’s operating cash is sufficient to cover its debt.
Can PEA meet its short-term obligations with the cash in hand?
With current liabilities at AU$30m, it seems that the business arguably has a rather low level of current assets relative its obligations, with the current ratio last standing at 0.78x. The current ratio is the number you get when you divide current assets by current liabilities.
Can PEA service its debt comfortably?
With debt reaching 44% of equity, PEA may be thought of as relatively highly levered. 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 PEA’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 PEA, the ratio of 8.82x suggests that interest is appropriately covered, which means that lenders may be willing to lend out more funding as PEA’s high interest coverage is seen as responsible and safe practice.
Although PEA’s debt level is towards the higher end of the spectrum, its cash flow coverage seems adequate to meet debt obligations which means its debt is being efficiently utilised. But, its low liquidity raises concerns over whether current asset management practices are properly implemented for the small-cap. Keep in mind I haven't considered other factors such as how PEA has been performing in the past. I suggest you continue to research Pacific Energy to get a more holistic view of the stock by looking at:
- Future Outlook : What are well-informed industry analysts predicting for PEA’s future growth? Take a look at our free research report of analyst consensus for PEA’s outlook.
- Valuation : What is PEA 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 PEA 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.