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 zero-debt makes the due diligence for potential investors less nerve-racking, it poses a new question: how should they assess the financial strength of such companies? I will take you through a few basic checks to assess the financial health of companies with no debt.
Does SPO’s growth rate justify its decision for financial flexibility over 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. Either SPO does not have access to cheap capital, or it may believe this trade-off is not worth it. This makes sense only if the company has a competitive edge and is growing fast off its equity capital. A single-digit revenue growth of 1.2% for SPO is considerably low for a small-cap company. More capital can help the business grow faster. If SPO is not expecting exceptional future growth, then the decision to avoid may cost shareholders in the long term.
Can SPO meet its short-term obligations with the cash in hand?
Given zero long-term debt on its balance sheet, Sportech 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 UK£24m liabilities, 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. Usually, for Hospitality companies, this is a suitable ratio as there’s enough of a cash buffer without holding too much capital in low return investments.
SPO 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, SPO’s financial situation may change. I admit this is a fairly basic analysis for SPO’s financial health. Other important fundamentals need to be considered alongside. I suggest you 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.
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.