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Creative Technology Ltd (SGX:C76), 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 C76 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 go over a basic overview of the stock’s financial health, which I believe provides a ballpark estimate of their financial health status.
View our latest analysis for Creative Technology
Is C76 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 C76 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, C76’s negative revenue growth of -5.5% hardly justifies opting for zero-debt. If the decline sustains, it may find it hard to raise debt at an acceptable cost.
Can C76 meet its short-term obligations with the cash in hand?
Given zero long-term debt on its balance sheet, Creative Technology 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. At the current liabilities level of US$23m liabilities, the company has been able to meet these obligations given the level of current assets of US$138m, with a current ratio of 6.04x. However, many consider anything above 3x to be quite high and could mean that C76 has too much idle capital in low-earning investments.
Next Steps:
Having no debt on the books means C76 has more financial freedom to keep growing at its current fast rate. This may mean this is an optimal capital structure for the business, given that it is also meeting its short-term commitment. Moving forward, its financial position may change. I admit this is a fairly basic analysis for C76’s financial health. Other important fundamentals need to be considered alongside. I recommend you continue to research Creative Technology to get a more holistic view of the stock by looking at: