Zero-debt allows substantial financial flexibility, especially for small-cap companies like XTD Limited (ASX:XTD), 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. While zero-debt makes the due diligence for potential investors less nerve-racking, it poses a new question: how should they assess the financial strength of such companies? I recommend you look at the following hurdles to assess XTD’s financial health. View our latest analysis for XTD
Is financial flexibility worth the lower cost of capital?
Debt capital generally has lower cost of capital compared to equity funding. 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 XTD’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 XTD is a high-growth company. Opposite to the high growth we were expecting, XTD’s negative revenue growth of -15.11% hardly justifies opting for zero-debt. If the decline sustains, it may find it hard to raise debt at an acceptable cost.
Can XTD meet its short-term obligations with the cash in hand?
Given zero long-term debt on its balance sheet, XTD 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 A$0.6M liabilities, it seems that the business has been able to meet these commitments with a current assets level of A$2.0M, leading to a 3.53x current account ratio. Though, anything about 3x may be excessive, since XTD may be leaving too much capital in low-earning investments.
Next Steps:
Are you a shareholder? Given that XTD is a relatively low-growth company, being in a zero-debt position isn’t always optimal. As an investor, you may want to figure out if there are company-specific reasons for not having any debt, and whether the company needs financial flexibility at this point in time. I suggest you take a look into a future growth analysis to properly assess what the market expects for the company moving forward.
Are you a potential investor? XTD’s management of short term liabilities is strong. However, its low sales growth could hurt returns, meaning there is some benefit to looking at low-cost funding alternatives. Keep in mind I haven’t considered other factors such as how XTD has been performing in the past. I encourage you to continue your research by taking a look at XTD’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.