Want to participate in a short research study? Help shape the future of investing tools and receive a $20 prize!
The direct benefit for Matrix Composites & Engineering Ltd (ASX:MCE), which sports a zero-debt capital structure, to include debt in its capital structure is the reduced cost of capital. However, the trade-off is MCE will have to adhere to stricter debt covenants and have less financial flexibility. Zero-debt can alleviate some risk associated with the company meeting debt obligations, but this doesn’t automatically mean MCE has outstanding financial strength. I recommend you look at the following hurdles to assess MCE’s financial health.
Is MCE growing fast enough to value financial flexibility over lower cost of capital?
Debt funding can be cheaper than issuing new equity due to lower interest cost on debt. But the downside of having debt in a company’s balance sheet is the debtholder’s higher claim on its assets in the case of liquidation, as well as stricter capital management requirements. MCE’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. MCE delivered a negative revenue growth of -14%. While its negative growth hardly justifies opting for zero-debt, if the decline sustains, it may find it hard to raise debt at an acceptable cost.
Does MCE’s liquid assets cover its short-term commitments?
Since Matrix Composites & Engineering 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 MCE’s AU$17m in current liabilities, the company has been able to meet these commitments with a current assets level of AU$32m, leading to a 1.84x current account ratio. For Energy Services companies, this ratio is within a sensible range as there’s enough of a cash buffer without holding too much capital in low return investments.
As a high-growth company, it may be beneficial for MCE 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. Moving forward, its financial position may be different. Keep in mind I haven’t considered other factors such as how MCE has been performing in the past. You should continue to research Matrix Composites & Engineering to get a better picture of the stock by looking at:
- Future Outlook: What are well-informed industry analysts predicting for MCE’s future growth? Take a look at our free research report of analyst consensus for MCE’s outlook.
- Historical Performance: What has MCE’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.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.