The direct benefit for Liquidity Services Inc (NASDAQ:LQDT), 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 LQDT will have to adhere to stricter debt covenants and have less financial flexibility. While LQDT 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 LQDT right in choosing financial flexibility over 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. The lack of debt on LQDT’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 LQDT is a high-growth company. LQDT delivered a negative revenue growth of -18.8%. While its negative growth hardly justifies opting for zero-debt, if the decline sustains, it may find it hard to raise debt at an acceptable cost.
Does LQDT’s liquid assets cover its short-term commitments?
Given zero long-term debt on its balance sheet, Liquidity Services has no solvency issues, which is 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. With current liabilities at US$65.6m, it appears that the company has been able to meet these commitments with a current assets level of US$121.2m, leading to a 1.85x current account ratio. Generally, for Internet companies, this is a reasonable ratio as there’s enough of a cash buffer without holding too capital in low return investments.
As a high-growth company, it may be beneficial for LQDT 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. In the future, LQDT’s financial situation may change. Keep in mind I haven’t considered other factors such as how LQDT has been performing in the past. I suggest you continue to research Liquidity Services to get a better picture of the stock by looking at:
- Historical Performance: What has LQDT’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.
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