The direct benefit for FARO Technologies Inc (NASDAQ:FARO), 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 FARO 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 recommend you look at the following hurdles to assess FARO’s financial health.
See our latest analysis for FARO Technologies
Is financial flexibility worth the lower cost of capital?
Debt capital generally has lower cost of capital compared to equity funding. But the downside of having debt in a company’s balance sheet is the debtholder’s higher claim on its assets in the case of liquidation, as well as stricter capital management requirements. The lack of debt on FARO’s balance sheet may be because it does not have access to cheap capital, or it may believe this trade-off is not worth it. Choosing financial flexibility over capital returns make sense if FARO is a high-growth company. A revenue growth in the teens is not considered high-growth. FARO’s revenue growth of 16% falls into this range. More capital can help the business grow faster. If FARO is not expecting exceptional future growth, then the decision to avoid may cost shareholders in the long term.
Can FARO pay its short-term liabilities?
Given zero long-term debt on its balance sheet, FARO Technologies has no solvency issues, which is used to describe the company’s ability to meet its long-term obligations. However, another measure of financial health is its short-term obligations, which is known as liquidity. These include payments to suppliers, employees and other stakeholders. At the current liabilities level of US$72m liabilities, it seems that the business has been able to meet these obligations given the level of current assets of US$298m, with a current ratio of 4.16x. However, anything above 3x may be considered excessive by some investors.
Next Steps:
Having no debt on the books means FARO has more financial freedom to keep growing at its current fast rate. This may mean this is an optimal capital structure for the business, given that it is also meeting its short-term commitment. Moving forward, its financial position may change. This is only a rough assessment of financial health, and I’m sure FARO has company-specific issues impacting its capital structure decisions. I recommend you continue to research FARO Technologies to get a better picture of the stock by looking at:
- Future Outlook: What are well-informed industry analysts predicting for FARO’s future growth? Take a look at our free research report of analyst consensus for FARO’s outlook.
- Valuation: What is FARO 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 FARO 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.