The direct benefit for Alcidion Group Limited (ASX:ALC), which sports a zero-debt capital structure, to include debt in its capital structure is the reduced cost of capital. The cost of debt is always less than that of equity as debt-holders have a superior claim over the company’s assets. In addition, interest on debt brings down taxable income, reducing the tax paid.
A drop in the cost of capital beefs up a company’s valuation as the same is used to discount its future cash flows to arrive at the intrinsic value — an estimate of its worth right now. 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, Alcidion Group 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. Check out our latest analysis for Alcidion Group
Is Alcidion Group right in choosing financial flexibility instead of a lower cost of capital?
For small-cap companies such as ALC with its market cap of USD $40 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. To fulfil this criteria, I expect a company to generate more than 20% revenue growth. In a complete contrast, ALC’s revenue contracted -21.46% over the past year. If the company is not expecting exceptional future growth, then its decision to avoid debt may cost shareholders dearly in the long-term.
Can ALC meet its short-term obligations with the cash in hand?
Given zero long-term debt on its balance sheet, Alcidion Group 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 ALC’s case, its short-term assets of $8 Million exceed the short-term liabilities of $1 Million, indicating sound liquidity position.
Alcidion Group has no long-term balance sheet, so there’s no bankruptcy risk. Additionally, with its liquid assets exceeding the short-term obligations, the company faces no liquidity issues. However, the company’s -21.46% growth rate raises concern over its decision to remain a zero-debt company. Now I recommend you check out our latest free analysis report to see what are ALC’s growth prospects and whether it could be considered an undervalued opportunity.
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