Zero-debt allows substantial financial flexibility, especially for small-cap companies like Senetas Corporation Limited (ASX:SEN), 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 SEN has no debt on its balance sheet, it doesn’t necessarily mean it exhibits financial strength. I will take you through a few basic checks to assess the financial health of companies with no debt.
Is SEN 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. 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 SEN 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. SEN’s revenue growth over the past year is a single-digit 7.8% which is relatively low for a small-cap company. More capital can help the business grow faster. If SEN is not expecting exceptional future growth, then the decision to avoid may cost shareholders in the long term.
Can SEN pay its short-term liabilities?
Given zero long-term debt on its balance sheet, Senetas has no solvency issues, which is 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. With current liabilities at AU$9.9m, it appears that the company has been able to meet these obligations given the level of current assets of AU$32m, with a current ratio of 3.17x. However, a ratio above 3x may be considered excessive by some investors, yet this is not usually a major negative for a company.
SEN 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 SEN’s liquidity needs, this may be its optimal capital structure for the time being. Going forward, SEN’s financial situation may change. This is only a rough assessment of financial health, and I’m sure SEN has company-specific issues impacting its capital structure decisions. I suggest you continue to research Senetas to get a better picture of the stock by looking at:
- Future Outlook: What are well-informed industry analysts predicting for SEN’s future growth? Take a look at our free research report of analyst consensus for SEN’s outlook.
- Valuation: What is SEN worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether SEN is currently mispriced by the market.
- 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 firstname.lastname@example.org.