What You Must Know About Servcorp Limited’s (ASX:SRV) Financial Health
Servcorp Limited (ASX:SRV), which has zero-debt on its balance sheet, can maximize capital returns by increasing debt due to its lower cost of capital. However, the trade-off is SRV will have to follow strict debt obligations which will reduce its financial flexibility. Zero-debt can alleviate some risk associated with the company meeting debt obligations, but this doesn’t automatically mean SRV has outstanding financial strength. I will take you through a few basic checks to assess the financial health of companies with no debt. View our latest analysis for Servcorp
Is SRV right in choosing financial flexibility over lower cost of capital?
Debt capital generally has lower cost of capital compared to equity funding. 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. SRV’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. SRV delivered a negative revenue growth of -1.59%. 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 SRV meet its short-term obligations with the cash in hand?
In addition to debtholders, a company must be able to pay its bills and salaries to keep the business running. During times of unfavourable events, SRV could be required to liquidate some of its assets to meet these upcoming payments, as cash flow from operations is hindered. We should examine if the company’s cash and short-term investment levels match its current liabilities. Our analysis shows that SRV does have enough liquid assets on hand to meet its upcoming liabilities, which lowers our concerns should adverse events arise.
Next Steps:
Are you a shareholder? As SRV’s revenues are not growing at a fast enough pace, having no debt on its balance sheet isn’t necessarily the best thing. Shareholders should understand why the company isn’t opting for cheaper cost of capital to fund future growth, and whether the company needs financial flexibility at this point in time. I recommend taking a look into a future growth analysis to properly assess the company’s position.
Are you a potential investor? SRV’s health in terms of financial liquidity should ease potential investors’ concerns. However, a relatively low revenue growth means there’s potential to improve return on capital by taking on some debt and ramp up growth. I admit this is a fairly basic analysis for SRV’s financial health. Other important fundamentals need to be considered alongside. You should continue your analysis by taking a look at SRV’s past performance to conclude on SRV’s financial health.
To help readers see pass 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.
