Any company, including Actual Experience plc (AIM:ACT) with no debt in its capital structure, would maximize capital returns by having an optimal capital structure, which includes debt. The debt reduces the overall cost of capital for the company. Due to its tax-benefits and legally-binding nature, it always costs less than equity.
A lower cost of capital increases a company’s valuation as it is the discount rate applied on future cash flows to calculate the present value; thus, indicating higher capital returns. Precisely due to the same reason, companies raised debt in their capital structure with costs at record lows in a low interest rate environment. This improved their capital returns and they were rewarded with higher valuations.
On the flip side, given the interest-rate hikes are a part of the economic cycle, Actual Experience will be in a stronger position compared to companies which would have to reduce debt due to rising interest-costs in such a scenario. While zero-debt makes the due-diligence for potential investors less nerve-racking, it poses a new question: how should they assess the financial strength of such companies? These are a few basic checks to assess the financial health of companies with no debt. See our latest analysis for ACT
Can Actual Experience’s growth rate justify focus on financial flexibility over lower cost of capital?
For small-cap companies such as ACT with its market cap of USD $117 Million, financial flexibility is a valuable option. And currently operating on a smaller scale, they’re not wrong in choosing it over improved total shareholder returns. However, choosing financial flexibility over capital returns is logical only if it’s a high-growth company. ACT’s revenue grew 36.86% over the past year, so it’s acceptable that the company is opting for a zero-debt capital structure currently as it may need to raise debt to fuel expansion in the future.
Does ACT’s cash and short-term assets cover its short-term commitments?
Given zero long-term debt on its balance sheet, Actual Experience has no solvency issues. Solvency is the company’s ability to meet its long-term obligations. But another important aspect of financial health is liquidity: the company’s ability to meet short-term obligations, which are mostly comprised of payments to suppliers, bank loans and debts due over the next twelve months. To cover them, a company must have more liquid assets than these obligations. In ACT’s case, its short-term assets of £14 Million exceed the short-term liabilities of £1 Million, indicating sound liquidity position.
Actual Experience is a fast growing company with a revenue growth of 36.86% over the past year, making financial flexibility a valuable option for the company. In addition, its current assets cover current liabilities, giving it enough liquidity to operate smoothly in the short-term. Now I recommend you check out our latest free analysis report to see what are ACT’s growth prospects and whether it could be considered an undervalued opportunity.
PS. If you are not interested in Actual Experience anymore, you can use our free platform to see my list of over 150 other stocks with a high growth potential.