The direct benefit for Allegra Orthopaedics Limited (ASX:AMT), 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 AMT will have to adhere to stricter debt covenants and have less financial flexibility. While AMT has no debt on its balance sheet, it doesn’t necessarily mean it exhibits financial strength. I will go over a basic overview of the stock’s financial health, which I believe provides a ballpark estimate of their financial health status.
Is financial flexibility worth the lower cost of capital?
There are well-known benefits of including debt in capital structure, primarily a lower cost of capital. However, the trade-off is debtholders’ higher claim on company assets in the event of liquidation and stringent obligations around capital management. Either AMT does not have access to cheap capital, or it may believe this trade-off is not worth it. This makes sense only if the company has a competitive edge and is growing fast off its equity capital. AMT delivered a negative revenue growth of -13%. 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 AMT’s liquid assets cover its short-term commitments?
Given zero long-term debt on its balance sheet, Allegra Orthopaedics has no solvency issues, which is 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 AMT’s AU$891k 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 6.67x. However, many consider a ratio above 3x to be high.
As a high-growth company, it may be beneficial for AMT to have some financial flexibility, hence zero-debt. Since there is also no concerns around AMT’s liquidity needs, this may be its optimal capital structure for the time being. Moving forward, its financial position may be different. This is only a rough assessment of financial health, and I’m sure AMT has company-specific issues impacting its capital structure decisions. I recommend you continue to research Allegra Orthopaedics to get a more holistic view of the stock by looking at:
- Historical Performance: What has AMT’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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