Earthport plc (LON:EPO), 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 EPO will have to follow strict debt obligations which will reduce its 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 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?
Debt funding can be cheaper than issuing new equity due to lower interest cost on debt. 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. Either EPO 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. EPO’s revenue growth in the teens of 18% is not considered as high-growth, especially for a small-cap company. More capital can help the business grow faster. If EPO is not expecting exceptional future growth, then the decision to avoid may cost shareholders in the long term.
Can EPO pay its short-term liabilities?
Given zero long-term debt on its balance sheet, Earthport 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£5m, it seems that the business has been able to meet these commitments with a current assets level of UK£43m, leading to a 8.49x current account ratio. Having said that, many consider anything above 3x to be quite high.
As a high-growth company, it may be beneficial for EPO to have some financial flexibility, hence zero-debt. Since there is also no concerns around EPO’s liquidity needs, this may be its optimal capital structure for the time being. Going forward, its financial position may be different. I admit this is a fairly basic analysis for EPO’s financial health. Other important fundamentals need to be considered alongside. I recommend you continue to research Earthport to get a better picture of the stock by looking at:
- Valuation: What is EPO 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 EPO is currently mispriced by the market.
- Historical Performance: What has EPO’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.