8common Limited (ASX:8CO), which has zero-debt on its balance sheet, can maximize capital returns by increasing debt due to its lower cost of capital. However, the trade-off is 8CO will have to follow strict debt obligations which will reduce its financial flexibility. While 8CO 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 8CO growing fast enough to value financial flexibility over lower cost of capital?
There are well-known benefits of including debt in capital structure, primarily a lower cost of capital. 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. The lack of debt on 8CO’s balance sheet may be because it does not have access to cheap capital, or it may believe this trade-off is not worth it. Choosing financial flexibility over capital returns make sense if 8CO is a high-growth company. A double-digit revenue growth of 24% is considered relatively high for a small-cap company like 8CO. So, it is acceptable that the company is opting for a zero-debt capital structure currently as it may need to raise debt to fuel expansion in the future.
Can 8CO meet its short-term obligations with the cash in hand?
Given zero long-term debt on its balance sheet, 8common 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. At the current liabilities level of AU$1m liabilities, the company has been able to meet these commitments with a current assets level of AU$4m, leading to a 3.06x current account ratio. However, a ratio greater than 3x may be considered as quite high.
Having no debt on the books means 8CO has more financial freedom to keep growing at its current fast rate. This may mean this is an optimal capital structure for the business, given that it is also meeting its short-term commitment. Going forward, 8CO’s financial situation may change. Keep in mind I haven’t considered other factors such as how 8CO has been performing in the past. You should continue to research 8common to get a more holistic view of the stock by looking at:
- Valuation: What is 8CO 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 8CO is currently mispriced by the market.
- Historical Performance: What has 8CO’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.
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.