The direct benefit for ENGlobal Corporation (NASDAQ:ENG), 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 ENG 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.
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. 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. Either ENG 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. ENG delivered a negative revenue growth of -7.8%. While its negative growth hardly justifies opting for zero-debt, if the decline sustains, it may find it hard to raise debt at an acceptable cost.
Does ENG’s liquid assets cover its short-term commitments?
Given zero long-term debt on its balance sheet, ENGlobal 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. At the current liabilities level of US$8m liabilities, it appears that the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 2.88x. Generally, for Energy Services companies, this is a reasonable ratio since there is a bit of a cash buffer without leaving too much capital in a low-return environment.
As a high-growth company, it may be beneficial for ENG to have some financial flexibility, hence zero-debt. 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, ENG’s financial situation may change. This is only a rough assessment of financial health, and I’m sure ENG has company-specific issues impacting its capital structure decisions. I recommend you continue to research ENGlobal to get a more holistic view of the stock by looking at:
- Historical Performance: What has ENG’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.
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