The direct benefit for Charles & Colvard, Ltd. (NASDAQ:CTHR), which sports a zero-debt capital structure, to include debt in its capital structure is the reduced cost of capital. However, the trade-off is CTHR will have to adhere to stricter debt covenants and have less financial flexibility. Zero-debt can alleviate some risk associated with the company meeting debt obligations, but this doesn’t automatically mean CTHR has outstanding financial strength. I will take you through a few basic checks to assess the financial health of companies with no debt.
Is CTHR right in choosing financial flexibility over lower cost of capital?
Debt funding can be cheaper than issuing new equity due to lower interest cost on debt. However, the trade-off is debtholders’ higher claim on company assets in the event of liquidation and stringent obligations around capital management. CTHR’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 single-digit revenue growth of 8.9% for CTHR is considerably low for a small-cap company. More capital can help the business grow faster. If CTHR is not expecting exceptional future growth, then the decision to avoid may cost shareholders in the long term.
Can CTHR meet its short-term obligations with the cash in hand?
Since Charles & Colvard 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. But another important aspect of financial health is liquidity: the company’s ability to meet short-term obligations, including payments to suppliers and employees. At the current liabilities level of US$4.9m, the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 3.29x. Having said that, a ratio above 3x may be considered excessive by some investors.
Having no debt on the books means CTHR has more financial freedom to keep growing at its current fast rate. This may mean this is an optimal capital structure for the business, given that it is also meeting its short-term commitment. In the future, its financial position may be different. This is only a rough assessment of financial health, and I’m sure CTHR has company-specific issues impacting its capital structure decisions. You should continue to research Charles & Colvard to get a better picture of the stock by looking at:
- Historical Performance: What has CTHR’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 firstname.lastname@example.org.