XPD Soccer Gear Group Limited (ASX:XPD), 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 XPD will have to follow strict debt obligations which will reduce its 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 will take you through a few basic checks to assess the financial health of companies with no debt.
Check out our latest analysis for XPD Soccer Gear Group
Is XPD growing fast enough to value 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. XPD’s absence of debt on its balance sheet may be due to lack of access to cheaper capital, or it may simply believe low cost is not worth sacrificing financial flexibility. However, choosing flexibility over capital returns is logical only if it’s a high-growth company. Opposite to the high growth we were expecting, XPD’s negative revenue growth of -17% hardly justifies opting for zero-debt. If the decline sustains, it may find it hard to raise debt at an acceptable cost.
Can XPD meet its short-term obligations with the cash in hand?
Since XPD Soccer Gear Group 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. But another important aspect of financial health is liquidity: the company’s ability to meet short-term obligations, including payments to suppliers and employees. With current liabilities at AU$13m, it appears that the company has been able to meet these obligations given the level of current assets of AU$92m, with a current ratio of 7.05x. Having said that, many consider anything above 3x to be quite high and could mean that XPD has too much idle capital in low-earning investments.
Next Steps:
Having no debt on the books means XPD has more financial freedom to keep growing at its current fast rate. Since there is also no concerns around XPD’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 XPD has been performing in the past. You should continue to research XPD Soccer Gear Group to get a more holistic view of the stock by looking at: