GBST Holdings Limited (ASX:GBT), 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 GBT will have to follow strict debt obligations which will reduce its financial flexibility. Zero-debt can alleviate some risk associated with the company meeting debt obligations, but this doesn’t automatically mean GBT has outstanding financial strength. I will take you through a few basic checks to assess the financial health of companies with no debt.
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Does GBT’s growth rate justify its decision for 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. The lack of debt on GBT’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 GBT is a high-growth company. A single-digit revenue growth of 0.3% for GBT is considerably low for a small-cap company. While its low growth hardly justifies opting for zero-debt, the company may have high growth projects in the pipeline to justify the trade-off.
Does GBT’s liquid assets cover its short-term commitments?
Given zero long-term debt on its balance sheet, GBST Holdings 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 GBT’s most recent AU$27.2m liabilities, it appears that the company has been able to meet these commitments with a current assets level of AU$36.5m, leading to a 1.34x current account ratio. Generally, for IT companies, this is a reasonable ratio as there’s enough of a cash buffer without holding too capital in low return investments.
Next Steps:
As a high-growth company, it may be beneficial for GBT to have some financial flexibility, hence zero-debt. Since there is also no concerns around GBT’s liquidity needs, this may be its optimal capital structure for the time being. Moving forward, its financial position may change. This is only a rough assessment of financial health, and I’m sure GBT has company-specific issues impacting its capital structure decisions. I suggest you continue to research GBST Holdings to get a more holistic view of the stock by looking at: