Zero-debt allows substantial financial flexibility, especially for small-cap companies like Distil plc (LON:DIS), 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 DIS has outstanding financial strength. I will take you through a few basic checks to assess the financial health of companies with no debt.
Is DIS growing fast enough to value financial flexibility over lower cost of capital?
Debt capital generally has lower cost of capital compared to equity funding. However, the trade-off is debtholders’ higher claim on company assets in the event of liquidation and stringent obligations around capital management. Either DIS does not have access to cheap capital, or it may believe this trade-off is not worth it. This makes sense only if the company has a competitive edge and is growing fast off its equity capital. A double-digit revenue growth of 22.7% is considered relatively high for a small-cap company like DIS. 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 DIS meet its short-term obligations with the cash in hand?
Given zero long-term debt on its balance sheet, Distil has no solvency issues, which is 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. Looking at DIS’s most recent UK£235.0k liabilities, the company has been able to meet these obligations given the level of current assets of UK£1.6m, with a current ratio of 6.82x. Though, a ratio greater than 3x may be considered as too high, as DIS could be holding too much capital in a low-return investment environment.
DIS 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 DIS’s liquidity needs, this may be its optimal capital structure for the time being. Going forward, its financial position may be different. This is only a rough assessment of financial health, and I’m sure DIS has company-specific issues impacting its capital structure decisions. I suggest you continue to research Distil to get a more holistic view of the stock by looking at:
- Valuation: What is DIS 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 DIS is currently mispriced by the market.
- Historical Performance: What has DIS’s returns been like over the past? Go into more detail in the past track record analysis and take a look at the free visual representations of our analysis for more clarity.
- 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 email@example.com.