Zero-debt allows substantial financial flexibility, especially for small-cap companies like VST Industries Limited (NSEI:VSTIND), 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 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. See our latest analysis for VST Industries
Is VSTIND right in choosing financial flexibility over 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. VSTIND’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 single-digit revenue growth of 7.42% for VSTIND is considerably 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 VSTIND pay its short-term liabilities?
Since VST Industries 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. 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 ₹2,477.7M liabilities, it appears that the company has been able to meet these commitments with a current assets level of ₹5,466.1M, leading to a 2.21x current account ratio. Generally, for tobacco companies, this is a reasonable ratio since there’s sufficient cash cushion without leaving too much capital idle or in low-earning investments.
Are you a shareholder? VSTIND's soft top-line growth means having no debt on its balance sheet isn't necessarily the best thing. As an investor, you may want to figure out if there are company-specific reasons for not having any debt, and whether the company needs financial flexibility at this point in time. I recommend taking a look into a future growth analysis to properly assess what the market expects for the company moving forward.
Are you a potential investor? The company's current holding of liquid assets gives it some level of security in any case of adverse events. However, a relatively low revenue growth could hurt returns, meaning there is some benefit to looking at low-cost funding alternatives. I admit this is a fairly basic analysis for VSTIND's financial health. Other important fundamentals need to be considered alongside. You should continue your analysis by taking a look at VSTIND's past performance to figure out VSTIND's financial health position.
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