The direct benefit for dorsaVi Ltd (ASX:DVL), 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 DVL 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 DVL has outstanding 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 DVL growing fast enough to value financial flexibility over lower cost of capital?
Debt capital generally has lower cost of capital compared to equity funding. 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. DVL’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. Opposite to the high growth we were expecting, DVL’s negative revenue growth of -0.9% hardly justifies opting for zero-debt. If the decline sustains, it may find it hard to raise debt at an acceptable cost.
Can DVL meet its short-term obligations with the cash in hand?
Given zero long-term debt on its balance sheet, dorsaVi 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. With current liabilities at AU$1.5m, it seems that the business has been able to meet these commitments with a current assets level of AU$6.7m, leading to a 4.58x current account ratio. Having said that, a ratio above 3x may be considered excessive by some investors.
As a high-growth company, it may be beneficial for DVL to have some financial flexibility, hence zero-debt. Since there is also no concerns around DVL’s liquidity needs, this may be its optimal capital structure for the time being. Going forward, its financial position may be different. I admit this is a fairly basic analysis for DVL’s financial health. Other important fundamentals need to be considered alongside. I suggest you continue to research dorsaVi to get a more holistic view of the stock by looking at:
- Historical Performance: What has DVL’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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