Zero-debt allows substantial financial flexibility, especially for small-cap companies like Emerson Radio Corp (NYSEMKT:MSN), 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 will take you through a few basic checks to assess the financial health of companies with no debt.
Does MSN’s growth rate justify its decision for financial flexibility over lower cost of capital?
Debt capital generally has lower cost of capital compared to equity funding. But the downside of having debt in a company’s balance sheet is the debtholder’s higher claim on its assets in the case of liquidation, as well as stricter capital management requirements. Either MSN 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. Opposite to the high growth we were expecting, MSN’s negative revenue growth of -19% hardly justifies opting for zero-debt. If the decline sustains, it may find it hard to raise debt at an acceptable cost.
Can MSN meet its short-term obligations with the cash in hand?
Given zero long-term debt on its balance sheet, Emerson Radio 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. At the current liabilities level of US$1m liabilities, it appears that the company has been able to meet these obligations given the level of current assets of US$46m, with a current ratio of 40.87x. Having said that, many consider anything above 3x to be quite high and could mean that MSN has too much idle capital in low-earning investments.
MSN is a fast-growing firm, which supports having have zero-debt and financial freedom to continue to ramp up growth. Since there is also no concerns around MSN’s liquidity needs, this may be its optimal capital structure for the time being. Going forward, its financial position may be different. Keep in mind I haven’t considered other factors such as how MSN has been performing in the past. I suggest you continue to research Emerson Radio to get a more holistic view of the stock by looking at:
- Historical Performance: What has MSN’s returns been like over the past? Go into more detail in the past track record analysis and take a look at the free visual representations of our analysis for more clarity.
- Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
To help readers see past 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. For errors that warrant correction please contact the editor at email@example.com.