The direct benefit for Tata Elxsi Limited (NSE:TATAELXSI), 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 TATAELXSI will have to adhere to stricter debt covenants and have less financial flexibility. Zero-debt can alleviate some risk associated with the company meeting debt obligations, but this doesn’t automatically mean TATAELXSI has outstanding financial strength. I will take you through a few basic checks to assess the financial health of companies with no debt.
See our latest analysis for Tata Elxsi
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. Though, the trade-offs are that lenders require stricter capital management requirements, in addition to having a higher claim on company assets relative to shareholders. TATAELXSI’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 revenue growth in the teens is not considered high-growth. TATAELXSI’s revenue growth of 16% falls into this range. 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 TATAELXSI meet its short-term obligations with the cash in hand?
Since Tata Elxsi 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. At the current liabilities level of ₹2.0b liabilities, it seems that the business has been able to meet these commitments with a current assets level of ₹8.9b, leading to a 4.4x current account ratio. However, a ratio greater than 3x may be considered as quite high, and some might argue TATAELXSI could be holding too much capital in a low-return investment environment.
Next Steps:
Having no debt on the books means TATAELXSI has more financial freedom to keep growing at its current fast rate. Since there is also no concerns around TATAELXSI’s liquidity needs, this may be its optimal capital structure for the time being. Moving forward, TATAELXSI’s financial situation may change. This is only a rough assessment of financial health, and I’m sure TATAELXSI has company-specific issues impacting its capital structure decisions. I suggest you continue to research Tata Elxsi to get a more holistic view of the stock by looking at:
- Future Outlook: What are well-informed industry analysts predicting for TATAELXSI’s future growth? Take a look at our free research report of analyst consensus for TATAELXSI’s outlook.
- Valuation: What is TATAELXSI 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 TATAELXSI 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 editorial-team@simplywallst.com.