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What does Lynas Corporation Limited’s (ASX:LYC) balance sheet tells us abouts its future?
While small-cap stocks, such as Lynas Corporation Limited (
ASX:LYC) with its market cap of USD $254 Million, are popular for their explosive growth, investors should also pay heed to their balance sheet to judge whether the company can survive a downturn. There are always disruptions which destabilize and many a times end an existing industry, and most small-cap companies are the first casualties when such a wave hits.
When a company is faced with an extreme event undercutting its profits or disrupting its operations temporarily, it’s the company’s ability to meet short-term obligations which allows it to remain in the business. These factors make a basic understanding of a company’s financial position of utmost importance for a new investor. Here are a few basic checks that are good enough to have a broad overview of the company’s financial strength.
Does Lynas generate an acceptable amount of cash through operations?
At the end of the day, a company must pay bills and salaries, and must be able to invest in lucrative projects through cash. Firms have a certain amount of control over revenue recognition, which makes an analysis of its operating cash flow even more important. In the case of Lynas, operating cash flow turned out to be 0.8% of its overall debt over the past twelve months. An annual operating cash flow of less than a tenth of the overall debt raises red flags, although short-term obstacles and cyclical nature of an industry may have an impact on a company’s ability to generate cash.
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Lynas (ASX:LYC) Historical Debt Apr 17
Can LYC meet its short-term obligations with the cash in hand?
While failure to manage cash has been one of the major reasons behind the demise of a lot of small businesses, the mismanagement comes into the limelight during tough situations such as economic recession, war, natural disaster, sudden increase in the price of raw materials, and a supply chain risk, which can put a company in a difficult situation. However, banks, creditors, wages, and commitment to suppliers do not go away even during an extreme event. So, a company must maintain enough liquidity to meet its short-term obligations to survive. Lynas is able to meet its short term (1 year) commitments with its holdings of cash and other short term assets.
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Lynas (ASX:LYC) Net Worth Apr 17
Is Lynas’s level of debt at an acceptable level?
A substantially higher-debt poses a significant threat to a company’s profitability during a downturn. Lynas’s debt to equity ratio stands at 577.2% and this indicates that the company is holding a high level of debt / liabilities compared to its net worth, and in the event of financial stress may experience difficulty meeting debt or interest obligations. While debt-to-equity ratio has several factors at play, an easier way to check whether it’s at a sustainable level is to check its ability to service the debt. A company generating earnings at least 5x of its interest payments is considered financially sound. In addition, with such a coverage ratio, the earnings remain more stable. In LYC’s case the company is making a loss, therefore interest on debt is not well covered by earnings.
Final words
Clearly, Lynas has a concerning amount of debt on its balance sheet. Additionally, the company fails to impress in terms of generating strong enough operating cash flows and earnings to cover annual interest expenses. Thus, for now, I don’t find it a financially sound company.
Now when you know whether you should keep the debt in mind as a risk factor when putting together your investment thesis.....
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