"Decmil appears to be healthy, but its operating cash flows and earnings tell a different story"

Decmil Group Limited (ASX: DCG): Does Low Debt-Load Make It A Financially Strong Company?

January 13, 2017

Small-cap companies such as Decmil Group Limited (ASX: DCG) with its market cap of USD $134 Million, have high growth potential but financial strength is the deciding factor in their long-term survival. On the surface, companies with a debt-to-equity ratio of less than 20% appear to have a sound debt structure, as is the case with DCG. But it is important you also look at other financial strength metrics to have the complete picture, like are they resilient enough to face an economic or industry downturn?

One of the major reasons that they are highly affected by a downturn in the country’s economy or an industry in the region is the lack of geographic diversification. So, investors often choose small-cap funds. On the other hand, well-versed investors allocate a small part of their portfolio capital to individual small-caps, primarily to improve its risk-return profile. However, that doesn’t reduce the risks these companies face individually. But I believe that it can be reduced to some extent by looking at these back of the hand balance sheet calculations.View our latest analysis for Decmil Group
How does Decmil Group’s operating cash flow stack against its overall debt?

Apart from a low-debt load, another highly important financial-check is whether the company can cover its operating expenses and generate enough cash to fund growth after paying interest on its debt. Strong, and positive, operating cash flow indicates that the company is profitable in its core activity. However, if the company is growing exceptionally fast, it’s acceptable that it depends on external sources of funding even to operate. Decmil Group is currently a negative operating cash flow company, implying that it relies on external funding sources even to operate. If the company does not become profitable at its core activities soon, it stands to face some serious financial distress and even a threat to its long-term survival.

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Does DCG nets enough to cover its debt-costs?

While operating cash flows are vital, earnings tell how profitable is the company, after also accounting for its gains and losses in non-core ventures and non-cash expenses such as depreciation and amortization. When a company earns enough to service its debt comfortably, this reflects its profitability and financial strength . 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 DCG’s case the company is making a loss, therefore interest on debt is not well covered by earnings.

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Final words

With such low debt on its balance sheet, while Decmil Group appeared to be a financially healthy company, its operating cash flows and earnings tell a different story. It needs to do a lot of work on its profitability and operational efficiency to be designated as a financially strong company.