The direct benefit for Frequency Electronics Inc (NASDAQ:FEIM), 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 FEIM will have to adhere to stricter debt covenants and have less financial flexibility. While FEIM has no debt on its balance sheet, it doesn’t necessarily mean it exhibits financial strength. 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 FEIM 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. The lack of debt on FEIM’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 FEIM is a high-growth company. Opposite to the high growth we were expecting, FEIM’s negative revenue growth of -24.4% hardly justifies opting for zero-debt. If the decline sustains, it may find it hard to raise debt at an acceptable cost.
Can FEIM pay its short-term liabilities?
Given zero long-term debt on its balance sheet, Frequency Electronics 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. With current liabilities at US$4.4m, the company has been able to meet these commitments with a current assets level of US$52.1m, leading to a 11.73x current account ratio. However, a ratio greater than 3x may be considered as quite high, and some might argue FEIM could be holding too much capital in a low-return investment environment.
FEIM is a fast-growing firm, which supports having have zero-debt and financial freedom to continue to ramp up growth. This may mean this is an optimal capital structure for the business, given that it is also meeting its short-term commitment. Going forward, its financial position may change. Keep in mind I haven’t considered other factors such as how FEIM has been performing in the past. I recommend you continue to research Frequency Electronics to get a more holistic view of the stock by looking at:
- Future Outlook: What are well-informed industry analysts predicting for FEIM’s future growth? Take a look at our free research report of analyst consensus for FEIM’s outlook.
- Valuation: What is FEIM 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 FEIM 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.