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Chant West Holdings Limited (ASX:CWL), 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 CWL will have to follow strict debt obligations which will reduce its financial flexibility. Zero-debt can alleviate some risk associated with the company meeting debt obligations, but this doesn’t automatically mean CWL has outstanding financial strength. I will take you through a few basic checks to assess the financial health of companies with no debt.
Is CWL growing fast enough to value financial flexibility over lower cost of capital?
Debt capital generally has lower cost of capital compared to equity funding. However, the trade-off is debtholders’ higher claim on company assets in the event of liquidation and stringent obligations around capital management. CWL’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. CWL’s revenue growth over the past year is a single-digit 2.9% which is relatively low for a small-cap company. More capital can help the business grow faster. If CWL is not expecting exceptional future growth, then the decision to avoid may cost shareholders in the long term.
Can CWL pay its short-term liabilities?
Given zero long-term debt on its balance sheet, Chant West Holdings 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. At the current liabilities level of AU$3.4m, the company has been able to meet these commitments with a current assets level of AU$3.4m, leading to a 1x current account ratio. Usually, for Software 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.
CWL is a fast-growing firm, which supports having have zero-debt and financial freedom to continue to ramp up growth. This may mean this is an optimal capital structure for the business, given that it is also meeting its short-term commitment. Going forward, CWL’s financial situation may change. This is only a rough assessment of financial health, and I’m sure CWL has company-specific issues impacting its capital structure decisions. I recommend you continue to research Chant West Holdings to get a better picture of the stock by looking at:
- Valuation: What is CWL 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 CWL is currently mispriced by the market.
- Historical Performance: What has CWL’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 firstname.lastname@example.org.