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Zero-debt allows substantial financial flexibility, especially for small-cap companies like Tristel Plc (LON:TSTL), 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. Zero-debt can alleviate some risk associated with the company meeting debt obligations, but this doesn’t automatically mean TSTL has outstanding financial strength. I recommend you look at the following hurdles to assess TSTL’s financial health.
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Does TSTL’s growth rate justify its decision for financial flexibility over lower cost of capital?
There are well-known benefits of including debt in capital structure, primarily a lower cost of capital. 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. The lack of debt on TSTL’s balance sheet may be because it does not have access to cheap capital, or it may believe this trade-off is not worth it. Choosing financial flexibility over capital returns make sense if TSTL is a high-growth company. TSTL’s revenue growth in the teens of 13% is not considered as high-growth, especially for a small-cap company. More capital can help the business grow faster. If TSTL is not expecting exceptional future growth, then the decision to avoid may cost shareholders in the long term.
Does TSTL’s liquid assets cover its short-term commitments?
Given zero long-term debt on its balance sheet, Tristel 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 UK£3m liabilities, the company has been able to meet these commitments with a current assets level of UK£11m, leading to a 3.76x current account ratio. Having said that, anything above 3x may be considered excessive by some investors. They might argue TSTL is leaving too much capital in low-earning investments.
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Having no debt on the books means TSTL has more financial freedom to keep growing at its current fast rate. Since there is also no concerns around TSTL’s liquidity needs, this may be its optimal capital structure for the time being. Going forward, its financial position may be different. I admit this is a fairly basic analysis for TSTL’s financial health. Other important fundamentals need to be considered alongside. I recommend you continue to research Tristel to get a more holistic view of the stock by looking at: