Zero-debt allows substantial financial flexibility, especially for small-cap companies like Iron Road Limited (ASX:IRD), 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. Zero-debt can alleviate some risk associated with the company meeting debt obligations, but this doesn’t automatically mean IRD has outstanding financial strength. I’ve put together a small checklist, which I believe provides a ballpark estimate of their financial health status. See our latest analysis for IRD
Is IRD 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. However, the trade-off is debtholders’ higher claim on company assets in the event of liquidation and stringent obligations around capital management. The lack of debt on IRD’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 IRD is a high-growth company.
Can IRD pay its short-term liabilities?
What about its other commitments such as payments to suppliers and salaries to its employees? As cash flow from operation is hindered by adverse events, IRD may need to liquidate its short-term assets to meet these upcoming payments. We test for IRD’s ability to meet these needs by comparing its cash and short-term investments with current liabilities. Our analysis shows that IRD does not have enough liquid assets on hand to meet its upcoming liabilities. Though this is a common practice, since cash is better utilized invested in the business or returned to shareholders, it does raise some concerns for investors should adverse events arise.
Next Steps:
Are you a shareholder? Having no debt on the books means IRD has more financial freedom to keep growing at its current fast rate. Though, the company’s low liquidity lowers our confidence around meeting near-term commitments. Some level of low-cost debt funding could help meet these needs. ] %} Going forward, its financial position may change. I recommend researching market expectations for IRD’s future growth.
Are you a potential investor? IRD’s high growth makes financial flexibility an attractive option. However, should adverse events arise, the company may struggle to meet its short-term obligations due to its low liquidity in assets. I encourage you to continue your research by taking a look at IRD’s past performance to figure out IRD’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.