AFT Corporation Limited (ASX:AFT), which has zero-debt on its balance sheet, can maximize capital returns by increasing debt due to its lower cost of capital. However, the trade-off is AFT will have to follow strict debt obligations which will reduce its financial flexibility. Zero-debt can alleviate some risk associated with the company meeting debt obligations, but this doesn’t automatically mean AFT 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 AFT
Is AFT growing fast enough to value financial flexibility over lower cost of capital?
There are well-known benefits of including debt in capital structure, primarily a lower cost of capital. 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 AFT’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 AFT is a high-growth company. AFT delivered a negative revenue growth of -24.85%. 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.
Can AFT meet its short-term obligations with the cash in hand?
Given zero long-term debt on its balance sheet, AFT 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. Looking at AFT’s most recent A$0.2M liabilities, the company has been able to meet these obligations given the level of current assets of A$0.4M, with a current ratio of 1.76x. Generally, for building companies, this is a reasonable ratio since there’s sufficient cash cushion without leaving too much capital idle or in low-earning investments.
Next Steps:
Are you a shareholder? As AFT’s revenues are not growing at a fast enough pace, being in a zero-debt position isn’t always optimal. As an investor, you may want to figure out if there are company-specific reasons for not having any debt, and whether the company needs financial flexibility at this point in time. I recommend taking a look into a future growth analysis to examine what the market expects for the company moving forward.