Jumbo Interactive Limited (ASX:JIN), 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 JIN will have to follow strict debt obligations which will reduce its financial flexibility. While JIN has no debt on its balance sheet, it doesn’t necessarily mean it exhibits financial strength. I will take you through a few basic checks to assess the financial health of companies with no debt. View our latest analysis for Jumbo Interactive
Is JIN 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. Either JIN 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. JIN delivered a negative revenue growth of -4.85%. 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 JIN pay its short-term liabilities?
Since Jumbo Interactive 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. 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. Looking at JIN’s most recent A$13.5M liabilities, the company has been able to meet these obligations given the level of current assets of A$43.9M, with a current ratio of 3.26x. Though, anything about 3x may be excessive, since JIN may be leaving too much capital in low-earning investments.
Next Steps:
Are you a shareholder? JIN’s soft top-line growth means 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. I recommend taking a look into a future growth analysis to examine what the market expects for the company moving forward.
Are you a potential investor? JIN’s health in terms of financial liquidity should ease potential investors’ concerns. However, its soft revenue growth means there’s potential to improve return on capital by taking on some debt and ramp up growth. Keep in mind I haven’t considered other factors such as how JIN has been performing in the past. You should continue your analysis by taking a look at JIN’s past performance in order to determine for yourself whether its zero-debt position is justified.
To help readers see pass 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.