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The direct benefit for Sportech PLC (LON:SPO), 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 SPO will have to adhere to stricter debt covenants and have less financial flexibility. While SPO has no debt on its balance sheet, it doesn’t necessarily mean it exhibits financial strength. I recommend you look at the following hurdles to assess SPO’s financial health.
Is financial flexibility worth the lower cost of capital?
Debt funding can be cheaper than issuing new equity due to lower interest cost on debt. However, the trade-off is debtholders’ higher claim on company assets in the event of liquidation and stringent obligations around capital management. SPO’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. SPO’s revenue growth over the past year is a single-digit 1.2% which is relatively low for a small-cap company. While its low growth hardly justifies opting for zero-debt, the company may have high growth projects in the pipeline to justify the trade-off.
Can SPO pay its short-term liabilities?
Since Sportech doesn’t have any debt on its balance sheet, it doesn’t have any solvency issues, which is a term 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 UK£24m, it appears that the company has been able to meet these commitments with a current assets level of UK£31m, leading to a 1.27x current account ratio. Generally, for Hospitality companies, this is a reasonable ratio since there’s a sufficient cash cushion without leaving too much capital idle or in low-earning investments.
SPO 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 SPO’s liquidity needs, this may be its optimal capital structure for the time being. Moving forward, its financial position may change. Keep in mind I haven’t considered other factors such as how SPO has been performing in the past. You should continue to research Sportech to get a better picture of the stock by looking at:
- Future Outlook: What are well-informed industry analysts predicting for SPO’s future growth? Take a look at our free research report of analyst consensus for SPO’s outlook.
- Historical Performance: What has SPO’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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If you spot an error that warrants correction, please contact the editor at email@example.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.