While small-cap stocks, such as Entertainment One Ltd. (LON:ETO) with its market cap of UK£2.3b, 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 vital, 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. Nevertheless, this is just a partial view of the stock, and I’d encourage you to dig deeper yourself into ETO here.
ETO’s Debt (And Cash Flows)
ETO's debt levels surged from UK£559m to UK£617m over the last 12 months – this includes long-term debt. With this rise in debt, ETO currently has UK£112m remaining in cash and short-term investments , ready to be used for running the business. Additionally, ETO has produced cash from operations of UK£65m during the same period of time, resulting in an operating cash to total debt ratio of 10%, signalling that ETO’s current level of operating cash is not high enough to cover debt.
Can ETO pay its short-term liabilities?
At the current liabilities level of UK£550m, it appears that the company has been able to meet these commitments with a current assets level of UK£835m, leading to a 1.52x current account ratio. The current ratio is the number you get when you divide current assets by current liabilities. For Entertainment companies, this ratio is within a sensible range as there's enough of a cash buffer without holding too much capital in low return investments.
Can ETO service its debt comfortably?
ETO is a relatively highly levered company with a debt-to-equity of 93%. This is somewhat unusual for small-caps companies, since lenders are often hesitant to provide attractive interest rates to less-established businesses. No matter how high the company’s debt, if it can easily cover the interest payments, it’s considered to be efficient with its use of excess leverage. A company generating earnings before interest and tax (EBIT) at least three times its net interest payments is considered financially sound. In ETO's case, the ratio of 1.96x suggests that interest is not strongly covered, which means that lenders may refuse to lend the company more money, as it is seen as too risky in terms of default.
ETO’s high cash coverage means that, although its debt levels are high, the company is able to utilise its borrowings efficiently in order to generate cash flow. This may mean this is an optimal capital structure for the business, given that it is also meeting its short-term commitment. Keep in mind I haven't considered other factors such as how ETO has been performing in the past. I recommend you continue to research Entertainment One to get a more holistic view of the small-cap by looking at:
- Future Outlook: What are well-informed industry analysts predicting for ETO’s future growth? Take a look at our free research report of analyst consensus for ETO’s outlook.
- Valuation: What is ETO 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 ETO 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 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.