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The direct benefit for Nordic Semiconductor ASA (OB:NOD), 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 NOD will have to adhere to stricter debt covenants and have less 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 recommend you look at the following hurdles to assess NOD’s financial health.
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Is financial flexibility worth the lower cost of capital?
Debt capital generally has lower cost of capital compared to equity funding. 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. The lack of debt on NOD’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 NOD is a high-growth company. NOD’s revenue growth over the past year is a double-digit 22% which is considerably high for a small-cap company. 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 NOD meet its short-term obligations with the cash in hand?
Given zero long-term debt on its balance sheet, Nordic Semiconductor 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 NOD’s US$44m in current liabilities, it appears that the company has been able to meet these commitments with a current assets level of US$223m, leading to a 5.03x current account ratio. Having said that, many consider a ratio above 3x to be high, although this is not necessarily a bad thing.
Next Steps:
Having no debt on the books means NOD has more financial freedom to keep growing at its current fast rate. Since there is also no concerns around NOD’s liquidity needs, this may be its optimal capital structure for the time being. Going forward, its financial position may change. Keep in mind I haven’t considered other factors such as how NOD has been performing in the past. I suggest you continue to research Nordic Semiconductor to get a better picture of the stock by looking at: