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Financial Stress Test Analysis

We complete a financial analysis of each company using data taken from their most recently audited financial statements. Our goal is to provide a snapshot of a company’s financial condition and ability to survive a prolonged period of reduced growth, and/or finance growth or restructuring to take advantage of new opportunities.

Cash Flows are Critical

We believe that cash flow is a critical metric in the near and medium term. In a recessionary, bear market environment equity financing will be difficult to obtain. As a result companies without sufficient cash flow to service debt properly are at risk of having to accept more debt on generally unattractive terms, or see their debt downgraded.

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Furthermore insufficient cash flow would impair the company’s ability to finance restructuring required as a result of any negative pandemic impact, or take advantage of opportunities to capture market share or launch new businesses.

Leverage Ratios as a Focus of Stress

Debt ratios are classic balance sheet health measuring tools used to indicate potential risks to future financing ability (ie. violating debt covenants) or as a barometer of the defensive position of the company if cash flows are ever an issue. They are long-term solvency metrics and reflect the degree to which the company is financing its operation through debt versus equity. If a company has poor leverage ratios (too much debt), it might need to aggressively finance its growth through debt and as a result require more and more cash flow from operations to adequately service its debt. Our view is that companies with less debt are more likely to be able to withstand challenges or fund opportunities created by the pandemic.

Recent Stress Tests

Financial Ratios

FL

Financial
Leverage

DC

Debt to
Capital

DA

Debt to
Assets

DE

Debt to
Equity

Key Stress Test Scores​

FCF

Free Cash
Flow

IC

Interest
Coverage

Name

Ticker

Stress Test Scores

Key Ratios

Ruth’s

Nasdaq: RUTH

FCF: A+ IC: A++

FL: 2.58X DC: 0.09 DA: 0.04 DE: 0.10

TJX Companies

NYSE: TJX

FCF: A+ IC: A++

FL: 2.58X DC: 0.09 DA: 0.04 DE: 0.10

Honeywell

NYSE: HON

FCF: A+ IC: A++

FL: 2.58X DC: 0.09 DA: 0.04 DE: 0.10

JD.com

Nasdaq: JD

FCF: A+ IC: A++

FL: 2.58X DC: 0.09 DA: 0.04 DE: 0.10

Cigna Corp.

NYSE: CI

FCF: A+ IC: A++

FL: 2.58X DC: 0.09 DA: 0.04 DE: 0.10

Honeywell

NYSE: HON

FCF: A+ IC: A++

FL: 2.58X DC: 0.09 DA: 0.04 DE: 0.10

Dominos Pizza

NYSE: DPZ

FCF: A+ IC: A++

FL: 2.58X DC: 0.09 DA: 0.04 DE: 0.10

Open Text

Nasdaq: OTEX

FCF: A+ IC: A++

FL: 2.58X DC: 0.09 DA: 0.04 DE: 0.10

Lululemon

Nasdaq: LULU

FCF: A+ IC: A++

FL: 2.58X DC: 0.09 DA: 0.04 DE: 0.10

GoEasy

TSE: GSY

FCF: A+ IC: A++

FL: 2.58X DC: 0.09 DA: 0.04 DE: 0.10

Papa John’s

Nasdaq: PZZA

FCF: A+ IC: A++

FL: 2.58X DC: 0.09 DA: 0.04 DE: 0.10

Trivago

Nasdaq: TRVG

FCF: A+ IC: A++

FL: 2.58X DC: 0.09 DA: 0.04 DE: 0.10

Chipotle 

NYSE: CMG

FCF: A+ IC: A++

FL: 2.58X DC: 0.09 DA: 0.04 DE: 0.10

Red Robin

Nasdaq: RRGB

FCF: A+ IC: A++

FL: 2.58X DC: 0.09 DA: 0.04 DE: 0.10

Fiesta Restaurant Grp

Nasdaq: FRGI

FCF: A+ IC: A++

FL: 2.58X DC: 0.09 DA: 0.04 DE: 0.10

Jack in the Box

Nasdaq: JACK

FCF: A+ IC: A++

FL: 2.58X DC: 0.09 DA: 0.04 DE: 0.10

Stress Test Scoring and Ratios

Debt Servicing

➤ Interest Coverage Ratio = EBIT / Interest Expense: A powerful measurement of the ‘survivability’ of a corporation. It reflects the ability of a company to pay interest on the outstanding debt and is thus an important assessment of short-term solvency. If the ratio is underneath 1.0 X, this means that the company cannot currently cover interest charges on its debt from current operational income. This could mean that the company is funding itself through the sale of assets or further financing; which are unsustainable. The higher the ratio, the higher probability to survive in the future financial hardship.

Free Cash Flow Valuation

➤ EV/FCF Ratio = Enterprise Value / Free Cash Flow: Based on our debt servicing thesis we primarily value companies based on their cash flows. We rely on the EV/FCF ratio to assess the total valuation of the company in relation to its ability to generate cash flows. Enterprise Value is the value of the entire company, both its debt and traded equity. When this is divided by its Free Cash Flow we see how much we are paying to buy that cash flow. The lower the ratio the cheaper it is to “buy” the cash flows of the company.

Key Ratios

➤ Financial Leverage Ratio = Total Debt / Total Equity: The Financial Leverage Ratio is a measure of the degree to which a company is financing its operations through debt. More specifically, it reflects the ability of shareholder equity to cover all outstanding debts in the event of a business downturn.

➤ Debt-to-Capital Ratio = Total Debt / (Total Debt + Total Shareholder’s Equity): The Debt-to-Capital ratio measures the amount of financial leverage in a company. This tells us whether a company is prone to using debt financing or equity financing. A company with a high Debt-to-Capital ratio, compared to a general or industry average, may be impared due to the cost of servicing debt and therefore increasing its default risk.

➤ Debt-to-Equity Ratio = Total Debt / Total Shareholder’s Equity: A high Debt-to-Equity ratio generally indicates that a company has been aggressive in financing its growth with debt. This can result in volatile earnings as a result of additional interest expense. If the company’s interest expense grows too high, it may increase the company’s chances of a default or bankruptcy.

➤ Debt-to-Assets Ratio = Total Debt / Total Assets: The Debt-to-Assets ratio shows the degree to which a company has used debt to finance its assets. This ratio can be used to evaluate whether a company has enough assets to meet its debt obligations. A ratio greater than 1 indicates that the entire company’s assets are worth less than its debt.