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The direct benefit for iSentric Limited (ASX:ICU), 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 ICU 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 ICU has outstanding financial strength. I will take you through a few basic checks to assess the financial health of companies with no debt.
Does ICU's growth rate justify its decision for financial flexibility over lower cost of capital?
There are well-known benefits of including debt in capital structure, primarily a lower cost of capital. Though, the trade-offs are that lenders require stricter capital management requirements, in addition to having a higher claim on company assets relative to shareholders. ICU’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. ICU’s revenue growth in the teens of 20% is not considered as high-growth, especially for a small-cap company. More capital can help the business grow faster. If ICU is not expecting exceptional future growth, then the decision to avoid may cost shareholders in the long term.
Can ICU pay its short-term liabilities?
Since iSentric 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 ICU’s AU$2.4m in current liabilities, it seems that the business has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 1.6x. For Interactive Media and 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.
Having no debt on the books means ICU has more financial freedom to keep growing at its current fast rate. Since there is also no concerns around ICU's liquidity needs, this may be its optimal capital structure for the time being. Moving forward, ICU's financial situation may change. I admit this is a fairly basic analysis for ICU's financial health. Other important fundamentals need to be considered alongside. I suggest you continue to research iSentric to get a better picture of the stock by looking at:
- Future Outlook: What are well-informed industry analysts predicting for ICU’s future growth? Take a look at our free research report of analyst consensus for ICU’s outlook.
- Valuation: What is ICU 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 ICU 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.