The Timken Company (NYSE:TKR) is a small-cap stock with a market capitalization of US$3.7b. 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? Evaluating financial health as part of your investment thesis is essential, as mismanagement of capital can lead to bankruptcies, which occur at a higher rate for small-caps. Let's work through some financial health checks you may wish to consider if you're interested in this stock. However, potential investors would need to take a closer look, and I’d encourage you to dig deeper yourself into TKR here.
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TKR’s Debt (And Cash Flows)
TKR has built up its total debt levels in the last twelve months, from US$1.1b to US$1.9b , which accounts for long term debt. With this growth in debt, the current cash and short-term investment levels stands at US$240m to keep the business going. Moreover, TKR has generated cash from operations of US$429m during the same period of time, leading to an operating cash to total debt ratio of 23%, indicating that TKR’s operating cash is sufficient to cover its debt.
Does TKR’s liquid assets cover its short-term commitments?
At the current liabilities level of US$684m, it seems that the business has been able to meet these obligations given the level of current assets of US$1.9b, with a current ratio of 2.81x. The current ratio is calculated by dividing current assets by current liabilities. Generally, for Machinery companies, this is a reasonable ratio since there's a sufficient cash cushion without leaving too much capital idle or in low-earning investments.
Can TKR service its debt comfortably?
TKR is a highly-leveraged company with debt exceeding equity by over 100%. 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 TKR’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 TKR, the ratio of 8.56x suggests that interest is appropriately covered, which means that lenders may be willing to lend out more funding as TKR’s high interest coverage is seen as responsible and safe practice.
Although TKR’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. 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 TKR's financial health. Other important fundamentals need to be considered alongside. I recommend you continue to research Timken to get a better picture of the small-cap by looking at:
- Future Outlook: What are well-informed industry analysts predicting for TKR’s future growth? Take a look at our free research report of analyst consensus for TKR’s outlook.
- Valuation: What is TKR 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 TKR 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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