The direct benefit for Keytone Dairy Corporation Limited (ASX:KTD), which sports a zero-debt capital structure, to include debt in its capital structure is the reduced cost of capital. However, the trade-off is KTD will have to adhere to stricter debt covenants and have less financial flexibility. 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 KTD’s financial health.
Is KTD right in choosing financial flexibility over 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. Either KTD 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. KTD’s revenue growth over the past year is a double-digit 31% which is considerably high for a small-cap company. Therefore, the company’s decision to choose financial flexibility is justified as it may need headroom to borrow in the future to sustain high growth.
Can KTD pay its short-term liabilities?
Since Keytone Dairy 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. Looking at KTD’s most recent NZ$102k liabilities, it appears that the company has been able to meet these commitments with a current assets level of NZ$2m, leading to a 15.81x current account ratio. Having said that, many consider anything above 3x to be quite high and could mean that KTD has too much idle capital in low-earning investments.
As a high-growth company, it may be beneficial for KTD to have some financial flexibility, hence zero-debt. This may mean this is an optimal capital structure for the business, given that it is also meeting its short-term commitment. Going forward, KTD’s financial situation may change. This is only a rough assessment of financial health, and I’m sure KTD has company-specific issues impacting its capital structure decisions. You should continue to research Keytone Dairy to get a more holistic view of the stock by looking at:
- Future Outlook: What are well-informed industry analysts predicting for KTD’s future growth? Take a look at our free research report of analyst consensus for KTD’s outlook.
- Historical Performance: What has KTD’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.