Altium Limited (ASX:ALU), 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 ALU 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 go over a basic overview of the stock’s financial health, which I believe provides a ballpark estimate of their financial health status.
Is financial flexibility worth the lower cost of capital?
There are well-known benefits of including debt in capital structure, primarily a lower cost of capital. 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. ALU’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. ALU’s revenue growth over the past year is a double-digit 27% which is considerably high for a small-cap company. 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.
Can ALU pay its short-term liabilities?
Since Altium 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. However, another measure of financial health is its short-term obligations, which is known as liquidity. These include payments to suppliers, employees and other stakeholders. With current liabilities at US$64m, the company has been able to meet these obligations given the level of current assets of US$95m, with a current ratio of 1.5x. Usually, for Software companies, this is a suitable ratio as there’s enough of a cash buffer without holding too much capital in low return investments.
As a high-growth company, it may be beneficial for ALU to have some financial flexibility, hence zero-debt. Since there is also no concerns around ALU’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 ALU has been performing in the past. I suggest you continue to research Altium to get a more holistic view of the stock by looking at:
- Future Outlook: What are well-informed industry analysts predicting for ALU’s future growth? Take a look at our free research report of analyst consensus for ALU’s outlook.
- Valuation: What is ALU worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether ALU is currently mispriced by the market.
- Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
To help readers see past 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. For errors that warrant correction please contact the editor at firstname.lastname@example.org.