Chant West Holdings Limited (ASX:CWL), 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 CWL 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 CWL has outstanding financial strength. I recommend you look at the following hurdles to assess CWL’s financial health.
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Is CWL growing fast enough to value financial flexibility over 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 CWL 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. CWL’s revenue growth over the past year is a single-digit 2.9% which is relatively low for a small-cap company. While its low growth hardly justifies opting for zero-debt, the company may have high growth projects in the pipeline to justify the trade-off.
Can CWL meet its short-term obligations with the cash in hand?
Given zero long-term debt on its balance sheet, Chant West Holdings 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 AU$3m, the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 1x. Usually, for Software companies, this is a suitable ratio as there’s enough of a cash buffer without holding too much capital in low return investments.
Next Steps:
CWL 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. Moving forward, its financial position may be different. Keep in mind I haven’t considered other factors such as how CWL has been performing in the past. You should continue to research Chant West Holdings to get a better picture of the stock by looking at: