Zero-debt allows substantial financial flexibility, especially for small-cap companies like iSentric Limited (ASX:ICU), as the company does not have to adhere to strict debt covenants. However, it also faces higher cost of capital given interest cost is generally lower than equity. While ICU 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.
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. Either ICU 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. A revenue growth in the teens is not considered high-growth. ICU’s revenue growth of 20% falls into this range. 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 meet its short-term obligations with the cash in hand?
Given zero long-term debt on its balance sheet, iSentric has no solvency issues, which is used to describe the company’s ability to meet its long-term obligations. However, another measure of financial health is its short-term obligations, which is known as liquidity. These include payments to suppliers, employees and other stakeholders. Looking at ICU’s most recent AU$2m liabilities, it appears that the company has been able to meet these commitments with a current assets level of AU$4m, leading to a 1.6x current account ratio. Usually, for Interactive Media and Services companies, this is a suitable ratio since there is a bit of a cash buffer without leaving too much capital in a low-return environment.
ICU is a fast-growing firm, which supports having have zero-debt and financial freedom to continue to ramp up growth. Since there is also no concerns around ICU’s liquidity needs, this may be its optimal capital structure for the time being. In the future, its financial position may be different. Keep in mind I haven’t considered other factors such as how ICU has been performing in the past. You should continue to research iSentric to get a more holistic view 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.
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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 firstname.lastname@example.org.