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The direct benefit for MOIL Limited (NSE:MOIL), which sports a zero-debt capital structure, to include debt in its capital structure is the reduced cost of capital. However, the trade-off is MOIL will have to adhere to stricter debt covenants and have less financial flexibility. While MOIL has no debt on its balance sheet, it doesn’t necessarily mean it exhibits financial strength. I recommend you look at the following hurdles to assess MOIL’s financial health.
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Does MOIL’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. 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 MOIL 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. A double-digit revenue growth of 34% is considered relatively high for a small-cap company like MOIL. So, it is acceptable that the company is opting for a zero-debt capital structure currently as it may need to raise debt to fuel expansion in the future.
Can MOIL pay its short-term liabilities?
Since MOIL doesn’t have any debt on its balance sheet, it doesn’t have any solvency issues, which is a term 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 ₹4.2b, the company has been able to meet these commitments with a current assets level of ₹26.0b, leading to a 6.16x current account ratio. However, a ratio greater than 3x may be considered as quite high, and some might argue MOIL could be holding too much capital in a low-return investment environment.
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As a high-growth company, it may be beneficial for MOIL to have some financial flexibility, hence zero-debt. Since there is also no concerns around MOIL’s liquidity needs, this may be its optimal capital structure for the time being. In the future, MOIL’s financial situation may change. Keep in mind I haven’t considered other factors such as how MOIL has been performing in the past. You should continue to research MOIL to get a better picture of the stock by looking at: