Registry Direct Limited (ASX:RD1), 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 RD1 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 RD1 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 Registry Direct
Want to help shape the future of investing tools and platforms? Take the survey and be part of one of the most advanced studies of stock market investors to date.
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. The lack of debt on RD1’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 RD1 is a high-growth company. Opposite to the high growth we were expecting, RD1’s negative revenue growth of -4.2% hardly justifies opting for zero-debt. If the decline sustains, it may find it hard to raise debt at an acceptable cost.
Can RD1 pay its short-term liabilities?
Since Registry Direct 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. 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$210k, the company has been able to meet these commitments with a current assets level of AU$573k, leading to a 2.73x current account ratio. For Software companies, this ratio is within a sensible range since there is a bit of a cash buffer without leaving too much capital in a low-return environment.
Next Steps:
Having no debt on the books means RD1 has more financial freedom to keep growing at its current fast rate. Since there is also no concerns around RD1’s liquidity needs, this may be its optimal capital structure for the time being. In the future, its financial position may change. Keep in mind I haven’t considered other factors such as how RD1 has been performing in the past. I suggest you continue to research Registry Direct to get a more holistic view of the stock by looking at: