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Zero-debt allows substantial financial flexibility, especially for small-cap companies like Electro Optic Systems Holdings Limited (ASX:EOS), as the company does not have to adhere to strict debt covenants. However, it also faces higher cost of capital given interest cost is generally lower than equity. Zero-debt can alleviate some risk associated with the company meeting debt obligations, but this doesn’t automatically mean EOS has outstanding 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 Electro Optic Systems Holdings
Is financial flexibility worth the lower cost of capital?
There are well-known benefits of including debt in capital structure, primarily a lower cost of capital. However, the trade-off is debtholders’ higher claim on company assets in the event of liquidation and stringent obligations around capital management. Either EOS 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. EOS’s revenue growth over the past year was an impressively high triple-digit rate, therefore the company’s decision to choose financial flexibility is justified as it may need headroom to borrow in the future to sustain high growth.
Can EOS pay its short-term liabilities?
Given zero long-term debt on its balance sheet, Electro Optic Systems Holdings 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. Looking at EOS’s most recent AU$25.1m liabilities, it seems that the business has been able to meet these commitments with a current assets level of AU$99.5m, leading to a 3.97x current account ratio. However, anything above 3x is considered high and could mean that EOS has too much idle capital in low-earning investments.
Next Steps:
As a high-growth company, it may be beneficial for EOS to have some financial flexibility, hence zero-debt. Since there is also no concerns around EOS’s liquidity needs, this may be its optimal capital structure for the time being. In the future, EOS’s financial situation may change. This is only a rough assessment of financial health, and I’m sure EOS has company-specific issues impacting its capital structure decisions. I recommend you continue to research Electro Optic Systems Holdings to get a more holistic view of the stock by looking at: