You Might Like McMillan Shakespeare Limited (ASX:MMS) But Do You Like Its Debt?
McMillan Shakespeare Limited (ASX:MMS) is a small-cap stock with a market capitalization of AU$1.0b. 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? Assessing first and foremost the financial health is 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, this is just a partial view of the stock, and I recommend you dig deeper yourself into MMS here.
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MMS’s Debt (And Cash Flows)
MMS's debt levels surged from AU$348m to AU$370m over the last 12 months , which accounts for long term debt. With this growth in debt, MMS's cash and short-term investments stands at AU$113m , ready to be used for running the business. Additionally, MMS has produced AU$127m in operating cash flow during the same period of time, resulting in an operating cash to total debt ratio of 34%, indicating that MMS’s debt is appropriately covered by operating cash.
Can MMS pay its short-term liabilities?
With current liabilities at AU$143m, it appears that the company has been able to meet these obligations given the level of current assets of AU$328m, with a current ratio of 2.29x. The current ratio is calculated by dividing current assets by current liabilities. For Professional Services companies, this ratio is within a sensible range since there is a bit of a cash buffer without leaving too much capital in a low-return environment.
Can MMS service its debt comfortably?
With debt reaching 99% of equity, MMS 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 MMS’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 MMS, the ratio of 14.24x suggests that interest is comfortably covered, which means that lenders may be inclined to lend more money to the company, as it is seen as safe in terms of payback.
Next Steps:
Although MMS’s debt level is towards the higher end of the spectrum, its cash flow coverage seems adequate to meet obligations which means its debt is being efficiently utilised. Since there is also no concerns around MMS's liquidity needs, this may be its optimal capital structure for the time being. Keep in mind I haven't considered other factors such as how MMS has been performing in the past. You should continue to research McMillan Shakespeare to get a more holistic view of the small-cap by looking at:
Future Outlook: What are well-informed industry analysts predicting for MMS’s future growth? Take a look at our free research report of analyst consensus for MMS’s outlook.
Valuation: What is MMS 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 MMS 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.