Zero-debt allows substantial financial flexibility, especially for small-cap companies like Insteel Industries Inc (NASDAQ:IIIN), 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 IIIN has outstanding financial strength. I recommend you look at the following hurdles to assess IIIN’s financial health.
Does IIIN’s growth rate justify its decision for financial flexibility over lower cost of capital?
Debt capital generally has lower cost of capital compared to equity funding. 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. IIIN’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 8.5% for IIIN is considerably low for a small-cap company. More capital can help the business grow faster. If IIIN is not expecting exceptional future growth, then the decision to avoid may cost shareholders in the long term.
Can IIIN meet its short-term obligations with the cash in hand?
Given zero long-term debt on its balance sheet, Insteel Industries 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 IIIN’s most recent US$44m liabilities, it seems that the business has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 3.62x. Having said that, many consider anything above 3x to be quite high and could mean that IIIN has too much idle capital in low-earning investments.
As a high-growth company, it may be beneficial for IIIN to have some financial flexibility, hence zero-debt. This may mean this is an optimal capital structure for the business, given that it is also meeting its short-term commitment. Going forward, IIIN’s financial situation may change. I admit this is a fairly basic analysis for IIIN’s financial health. Other important fundamentals need to be considered alongside. I suggest you continue to research Insteel Industries to get a better picture of the stock by looking at:
- Future Outlook: What are well-informed industry analysts predicting for IIIN’s future growth? Take a look at our free research report of analyst consensus for IIIN’s outlook.
- Valuation: What is IIIN 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 IIIN 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.
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