Zero-debt allows substantial financial flexibility, especially for small-cap companies like Qualstar Corporation (NASDAQ:QBAK), 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 QBAK 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. Check out our latest analysis for Qualstar
Is QBAK 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. 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. QBAK’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. Opposite to the high growth we were expecting, QBAK’s negative revenue growth of -14.22% hardly justifies opting for zero-debt. If the decline sustains, it may find it hard to raise debt at an acceptable cost.
Can QBAK meet its short-term obligations with the cash in hand?
Given zero long-term debt on its balance sheet, Qualstar 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. At the current liabilities level of $2.3M liabilities, it seems that the business has been able to meet these commitments with a current assets level of $6.9M, leading to a 3.06x current account ratio. However, anything above 3x is considered high and could mean that QBAK has too much idle capital in low-earning investments.
Are you a shareholder? As QBAK’s revenues are not growing at a fast enough pace, being in a zero-debt position isn’t always optimal. Shareholders should understand why the company isn’t opting for cheaper cost of capital to fund future growth, and why financial flexibility is needed at this stage in its business cycle. You should take a look into a future growth analysis to properly assess what the market expects for the company moving forward.
Are you a potential investor? QBAK’s management of short term liabilities is strong. But, its soft revenue growth could hurt returns, meaning there is some benefit to looking at low-cost funding alternatives. Keep in mind I haven’t considered other factors such as how QBAK has been performing in the past. For your next step, you should take a look at QBAK’s past performance in order to determine for yourself whether its zero-debt position is justified.
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.