The direct benefit for Scott Technology Limited (NZSE:SCT), 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 SCT will have to adhere to stricter debt covenants and have less financial flexibility. Zero-debt can alleviate some risk associated with the company meeting debt obligations, but this doesn’t automatically mean SCT has outstanding financial strength. I recommend you look at the following hurdles to assess SCT’s financial health. See our latest analysis for SCT
Is SCT growing fast enough to value financial flexibility over lower cost of capital?
Debt funding can be cheaper than issuing new equity due to lower interest cost on debt. 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 SCT’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 SCT is a high-growth company. SCT’s revenue growth in the teens of 18.37% is not considered as high-growth, especially 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.
Can SCT meet its short-term obligations with the cash in hand?
What about its commitments to other stakeholders such as payments to suppliers and employees? In times of adverse events, SCT may need to liquidate its short-term assets to pay these immediate obligations. We should examine if the company’s cash and short-term investment levels match its current liabilities. Our analysis shows that SCT is able to meet its upcoming commitments with its cash and other short-term assets, which lessens our concerns for the company’s business operations should any unfavourable circumstances arise.
Next Steps:
Are you a shareholder? SCT’s soft top-line growth means not taking advantage of lower cost debt may not be the best strategy. Shareholders should understand why the company isn’t opting for cheaper cost of capital to fund future growth, and whether the company needs financial flexibility at this point in time. I suggest you take a look into a future growth analysis to account for what the market expects for the company moving forward.
Are you a potential investor? SCT’s financial health in terms of its liquidity shouldn’t be a concern for potential investors. However, its low sales growth could hurt returns, meaning there is some benefit to looking at low-cost funding alternatives. Keep in mind I haven’t considered other factors such as how SCT has been performing in the past. For your next step, you should take a look at SCT’s past performance to figure out SCT’s financial health position.
To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned.