Synertec Corporation Limited (ASX:SOP), which has zero-debt on its balance sheet, can maximize capital returns by increasing debt due to its lower cost of capital. However, the trade-off is SOP will have to follow strict debt obligations which will reduce its financial flexibility. 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? I will take you through a few basic checks to assess the financial health of companies with no debt.
Is financial flexibility worth the lower cost of capital?
Debt funding can be cheaper than issuing new equity due to lower interest cost on debt. However, the trade-off is debtholders’ higher claim on company assets in the event of liquidation and stringent obligations around capital management. SOP’s absence of debt on its balance sheet may be due to lack of access to cheaper capital, or it may simply believe low cost is not worth sacrificing financial flexibility. However, choosing flexibility over capital returns is logical only if it’s a high-growth company. Opposite to the high growth we were expecting, SOP’s negative revenue growth of -22% hardly justifies opting for zero-debt. If the decline sustains, it may find it hard to raise debt at an acceptable cost.
Can SOP pay its short-term liabilities?
Since Synertec doesn’t have any debt on its balance sheet, it doesn’t have any solvency issues, which is a term used to describe 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, including payments to suppliers and employees. With current liabilities at AU$6.2m, the company has been able to meet these commitments with a current assets level of AU$9.2m, leading to a 1.49x current account ratio. Generally, for Professional Services companies, this is a reasonable ratio since there is a bit of a cash buffer without leaving too much capital in a low-return environment.
Having no debt on the books means SOP has more financial freedom to keep growing at its current fast rate. Since there is also no concerns around SOP’s liquidity needs, this may be its optimal capital structure for the time being. Moving forward, its financial position may change. This is only a rough assessment of financial health, and I’m sure SOP has company-specific issues impacting its capital structure decisions. I recommend you continue to research Synertec to get a more holistic view of the stock by looking at:
- Future Outlook: What are well-informed industry analysts predicting for SOP’s future growth? Take a look at our free research report of analyst consensus for SOP’s outlook.
- Valuation: What is SOP 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 SOP 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.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.