Charles & Colvard Ltd (NASDAQ:CTHR), which has zero-debt on its balance sheet, can maximize capital returns by increasing debt due to its lower cost of capital. However, the trade-off is CTHR will have to follow strict debt obligations which will reduce its 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 will take you through a few basic checks to assess the financial health of companies with no debt. Check out our latest analysis for Charles & Colvard
Is CTHR growing fast enough to value financial flexibility over lower cost of capital?
Debt capital generally has lower cost of capital compared to equity funding. 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. CTHR’s absence of debt on its balance sheet may be due to lack of access to cheaper capital, or it may simply believe low cost is not worth sacrificing financial flexibility. However, choosing flexibility over capital returns is logical only if it’s a high-growth company. A revenue growth in the teens is not considered high-growth. CTHR’s revenue growth of 13.52% falls into this range. More capital can help the business grow faster. If CTHR is not expecting exceptional future growth, then the decision to avoid may cost shareholders in the long term.
Can CTHR pay its short-term liabilities?
Given zero long-term debt on its balance sheet, Charles & Colvard 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. Looking at CTHR’s most recent $4.6M liabilities, the company has been able to meet these obligations given the level of current assets of $20.7M, with a current ratio of 4.49x. Though, anything about 3x may be excessive, since CTHR may be leaving too much capital in low-earning investments.
Next Steps:
Are you a shareholder? Since CTHR is a low-growth stock in terms of its revenues, not having any low-cost debt funding may not be optimal for the business. 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. I recommend taking a look into a future growth analysis to properly assess the company’s position.