Zero-debt allows substantial financial flexibility, especially for small-cap companies like Mitcham Industries Inc (NASDAQ:MIND), 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. While zero-debt makes the due diligence for potential investors less nerve-racking, it poses a new question: how should they assess the financial strength of such companies? 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 MIND 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. 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. MIND’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. MIND delivered a negative revenue growth of -30%. 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.
Can MIND meet its short-term obligations with the cash in hand?
Given zero long-term debt on its balance sheet, Mitcham Industries 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$8m, it appears that the company has been able to meet these commitments with a current assets level of US$32m, leading to a 3.97x current account ratio. However, a ratio greater than 3x may be considered as quite high.
MIND 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 MIND’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 MIND has company-specific issues impacting its capital structure decisions. I suggest you continue to research Mitcham Industries to get a more holistic view of the stock by looking at:
- Valuation: What is MIND 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 MIND is currently mispriced by the market.
- Historical Performance: What has MIND’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.