The direct benefit for SD Standard Drilling Plc (OB:SDSD), 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 SDSD 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 go over a basic overview of the stock’s financial health, which I believe provides a ballpark estimate of their financial health status. See our latest analysis for S.D. Standard Drilling
Is financial flexibility worth the lower cost of capital?
Debt capital generally has lower cost of capital compared to equity funding. 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. SDSD’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, SDSD’s negative revenue growth of -379.61% hardly justifies opting for zero-debt. If the decline sustains, it may find it hard to raise debt at an acceptable cost.
Can SDSD pay its short-term liabilities?
Given zero long-term debt on its balance sheet, S.D. Standard Drilling 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 US$217.00k, it appears that the company has been able to meet these commitments with a current assets level of US$20.96m, leading to a 96.57x current account ratio. However, a ratio greater than 3x may be considered as too high, as SDSD could be holding too much capital in a low-return investment environment.
Next Steps:
SDSD 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. In the future, SDSD’s financial situation may change. Keep in mind I haven’t considered other factors such as how SDSD has been performing in the past. I recommend you continue to research S.D. Standard Drilling to get a more holistic view of the stock by looking at:
- Future Outlook: What are well-informed industry analysts predicting for SDSD’s future growth? Take a look at our free research report of analyst consensus for SDSD’s outlook.
- Valuation: What is SDSD 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 SDSD 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.