Zero-debt allows substantial financial flexibility, especially for small-cap companies like Spirent Communications plc (LON:SPT), 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. While SPT 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 SPT’s financial health.
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. However, the trade-off is debtholders’ higher claim on company assets in the event of liquidation and stringent obligations around capital management. SPT’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. Opposite to the high growth we were expecting, SPT’s negative revenue growth of -1.7% hardly justifies opting for zero-debt. If the decline sustains, it may find it hard to raise debt at an acceptable cost.
Can SPT meet its short-term obligations with the cash in hand?
Since Spirent Communications 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. Looking at SPT’s most recent US$115m liabilities, the company has been able to meet these obligations given the level of current assets of US$235m, with a current ratio of 2.05x. Usually, for Communications companies, this is a suitable ratio since there’s a sufficient cash cushion without leaving too much capital idle or in low-earning investments.
SPT 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. Moving forward, its financial position may change. Keep in mind I haven’t considered other factors such as how SPT has been performing in the past. You should continue to research Spirent Communications to get a more holistic view of the stock by looking at:
- Future Outlook: What are well-informed industry analysts predicting for SPT’s future growth? Take a look at our free research report of analyst consensus for SPT’s outlook.
- Valuation: What is SPT 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 SPT 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 email@example.com.