Zero-debt allows substantial financial flexibility, especially for small-cap companies like Alpha and Omega Semiconductor Limited (NASDAQ:AOSL), 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 AOSL 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 AOSL
Is AOSL right in choosing 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. AOSL’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. A revenue growth in the teens is not considered high-growth. AOSL’s revenue growth of 14.20% falls into this range. 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 AOSL meet its short-term obligations with the cash in hand?
What about its commitments to other stakeholders such as payments to suppliers and employees? During times of unfavourable events, AOSL could be required to liquidate some of its assets to meet these upcoming payments, as cash flow from operations is hindered. We should examine if the company’s cash and short-term investment levels match its current liabilities. Our analysis shows that AOSL 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.
Are you a shareholder? Since AOSL is a low-growth stock in terms of its revenues, not having any low-cost debt funding may not be optimal for the business. As an investor, you may want to figure out if there are company-specific reasons for not having any debt, and whether the company needs financial flexibility at this point in time. You should take a look into a future growth analysis to examine the company’s position.
Are you a potential investor? In terms of meeting is short term obligations, there’s nothing to worry about for AOSL. However, its low sales growth means there’s potential to improve return on capital by taking on some debt and ramp up growth. This is only a rough assessment of financial health, and I’m sure AOSL has company-specific issues impacting its capital structure decisions. I encourage you to continue your research by taking a look at AOSL’s past performance to conclude on AOSL’s financial health.
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.