Entek Energy Limited (ASX:ETE), 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 ETE will have to follow strict debt obligations which will reduce its financial flexibility. Zero-debt can alleviate some risk associated with the company meeting debt obligations, but this doesn’t automatically mean ETE has outstanding financial strength. I recommend you look at the following hurdles to assess ETE’s financial health.
Is ETE right in choosing financial flexibility over lower cost of capital?
Debt capital generally has lower cost of capital compared to equity funding. However, the trade-off is debtholders’ higher claim on company assets in the event of liquidation and stringent obligations around capital management. The lack of debt on ETE’s balance sheet may be because it does not have access to cheap capital, or it may believe this trade-off is not worth it. Choosing financial flexibility over capital returns make sense if ETE is a high-growth company. ETE delivered a strikingly high triple-digit revenue growth over the past year, so it is 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.
Can ETE pay its short-term liabilities?
Since Entek Energy 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. Looking at ETE’s AU$331k in current liabilities, it appears that the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 13.57x. Having said that, a ratio above 3x may be considered excessive by some investors.
As a high-growth company, it may be beneficial for ETE to have some financial flexibility, hence zero-debt. This may mean this is an optimal capital structure for the business, given that it is also meeting its short-term commitment. In the future, its financial position may be different. This is only a rough assessment of financial health, and I’m sure ETE has company-specific issues impacting its capital structure decisions. You should continue to research Entek Energy to get a more holistic view of the stock by looking at:
- Historical Performance: What has ETE’s returns been like over the past? Go into more detail in the past track record analysis and take a look at the free visual representations of our analysis for more clarity.
- 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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