Zero-debt allows substantial financial flexibility, especially for small-cap companies like Mesoblast Limited (ASX:MSB), 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 MSB has outstanding financial strength. I will go over a basic overview of the stock’s financial health, which I believe provides a ballpark project of their financial health status. Check out our latest analysis for Mesoblast
Is financial flexibility worth the 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. The lack of debt on MSB’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 MSB is a high-growth company. MSB delivered a negative revenue growth of -94.33%. 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 MSB pay its short-term liabilities?
Given zero long-term debt on its balance sheet, Mesoblast 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 $36.7M liabilities, the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 1.73x. Generally, for biotechs companies, this is a reasonable ratio since there is a bit of a cash buffer without leaving too much capital in a low-return environment.
Next Steps:
Are you a shareholder? Since MSB is a low-growth stock in terms of its revenues, not taking advantage of lower cost debt may not be the best strategy. Shareholders should understand why the company isn’t opting for cheaper cost of capital to fund future growth, and why financial flexibility is needed at this stage in its business cycle. You should take a look into a future growth analysis to account for what the market expects for the company moving forward.