The direct benefit for Barnwell Industries Inc (AMEX:BRN), 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 BRN will have to adhere to stricter debt covenants and have less financial flexibility. While BRN has no debt on its balance sheet, it doesn’t necessarily mean it exhibits financial strength. 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 Barnwell Industries
Is financial flexibility worth the lower cost of capital?
Debt capital generally has lower cost of capital compared to equity funding. However, the trade-off is debtholders’ higher claim on company assets in the event of liquidation and stringent obligations around capital management. BRN’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. BRN delivered a negative revenue growth of -4.38%. 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 BRN’s liquid assets cover its short-term commitments?
Since Barnwell 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. Looking at BRN’s most recent $4.8M liabilities, it appears that the company has been able to meet these commitments with a current assets level of $25.1M, leading to a 5.24x current account ratio. Though, anything above 3x is considered high and could mean that BRN has too much idle capital in low-earning investments.
As BRN’s revenues are not growing at a fast enough pace, not having any low-cost debt funding may not be optimal for the business. As an investor, you may want to figure out if there are company-specific reasons for not having any debt, and why financial flexibility is needed at this stage in its business cycle. Keep in mind I haven’t considered other factors such as how BRN has been performing in the past. You should continue to research Barnwell Industries to get a better picture of the stock by looking at:
1. Valuation: What is BRN 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 BRN is currently mispriced by the market.
2. Historical Performance: What has BRN’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.
3. 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.