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Zero-debt allows substantial financial flexibility, especially for small-cap companies like Silex Systems Limited (ASX:SLX), 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 SLX has outstanding financial strength. I recommend you look at the following hurdles to assess SLX’s financial health.
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Does SLX’s growth rate justify its decision for financial flexibility over lower cost of capital?
Debt funding can be cheaper than issuing new equity due to lower interest cost on debt. However, the trade-off is debtholders’ higher claim on company assets in the event of liquidation and stringent obligations around capital management. The lack of debt on SLX’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 SLX is a high-growth company. SLX delivered a negative revenue growth of -17%. 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 SLX meet its short-term obligations with the cash in hand?
Since Silex Systems 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. At the current liabilities level of AU$2.6m, the company has been able to meet these commitments with a current assets level of AU$50m, leading to a 19.19x current account ratio. However, many consider a ratio above 3x to be high.
Next Steps:
As a high-growth company, it may be beneficial for SLX to have some financial flexibility, hence zero-debt. Since there is also no concerns around SLX’s liquidity needs, this may be its optimal capital structure for the time being. Moving forward, its financial position may change. Keep in mind I haven’t considered other factors such as how SLX has been performing in the past. You should continue to research Silex Systems to get a better picture of the stock by looking at: