Zero-debt allows substantial financial flexibility, especially for small-cap companies like MGC Pharmaceuticals Limited (ASX:MXC), as the company does not have to adhere to strict debt covenants. However, it also faces higher cost of capital given interest cost is generally lower than equity. 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. See our latest analysis for MXC
Does MXC’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. MXC’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. MXC’s revenue growth over the past year was an impressively high triple-digit rate, therefore the company’s decision to choose financial flexibility is justified as it may need headroom to borrow in the future to sustain high growth.
Does MXC’s liquid assets cover its short-term commitments?
In addition to debtholders, a company must be able to pay its bills and salaries to keep the business running. As cash flow from operation is hindered by adverse events, MXC may need to liquidate its short-term assets to meet these upcoming payments. We should examine if the company’s cash and short-term investment levels match its current liabilities. Our analysis shows that MXC does have enough liquid assets on hand to meet its upcoming liabilities, which lowers our concerns should adverse events arise.
Next Steps:
Are you a shareholder? MXC is a fast-growing firm, which supports having have zero-debt and financial freedom to continue to ramp up growth. Since there is also no concerns around MXC’s liquidity needs, this may be its optimal capital structure for the time being. Moving forward, its financial position may change. I suggest keeping on top of market expectations for MXC’s future growth.
Are you a potential investor? MGC Pharmaceuticals is a fast-growing company, making financial flexibility a valuable option for the company. Moreover, its high liquidity ensures the company will continue to operate smoothly should unfavourable circumstances arise. To gain more conviction in the stock, you need to also examine MXC’s track record. As a following step, you should take a look at MXC’s past performance to figure out MXC’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.