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Zero-debt allows substantial financial flexibility, especially for small-cap companies like Focusrite Plc (LON:TUNE), 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. Zero-debt can alleviate some risk associated with the company meeting debt obligations, but this doesn’t automatically mean TUNE 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 financial flexibility worth the 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. TUNE’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. A revenue growth in the teens is not considered high-growth. TUNE’s revenue growth of 14% falls into this range. More capital can help the business grow faster. If TUNE is not expecting exceptional future growth, then the decision to avoid may cost shareholders in the long term.
Does TUNE’s liquid assets cover its short-term commitments?
Given zero long-term debt on its balance sheet, Focusrite 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. With current liabilities at UK£11m, it seems that the business has been able to meet these obligations given the level of current assets of UK£48m, with a current ratio of 4.28x. Having said that, many consider a ratio above 3x to be high, although this is not necessarily a bad thing.
Having no debt on the books means TUNE has more financial freedom to keep growing at its current fast rate. Since there is also no concerns around TUNE’s liquidity needs, this may be its optimal capital structure for the time being. In the future, TUNE’s financial situation may change. This is only a rough assessment of financial health, and I’m sure TUNE has company-specific issues impacting its capital structure decisions. You should continue to research Focusrite to get a more holistic view of the stock by looking at:
- Future Outlook: What are well-informed industry analysts predicting for TUNE’s future growth? Take a look at our free research report of analyst consensus for TUNE’s outlook.
- Valuation: What is TUNE 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 TUNE 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 firstname.lastname@example.org.