Zero-debt allows substantial financial flexibility, especially for small-cap companies like Sabine Royalty Trust (NYSE:SBR), 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 recommend you look at the following hurdles to assess SBR’s financial health.
Is financial flexibility worth the lower cost of capital?
Debt funding can be cheaper than issuing new equity due to lower interest cost on debt. However, the trade-off is debtholders’ higher claim on company assets in the event of liquidation and stringent obligations around capital management. Either SBR does not have access to cheap capital, or it may believe this trade-off is not worth it. This makes sense only if the company has a competitive edge and is growing fast off its equity capital. A revenue growth in the teens is not considered high-growth. SBR’s revenue growth of 18.1% falls into this range. While its low growth hardly justifies opting for zero-debt, the company may have high growth projects in the pipeline to justify the trade-off.
Can SBR pay its short-term liabilities?
Since Sabine Royalty Trust doesn’t have any debt on its balance sheet, it doesn’t have any solvency issues, which is a term 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. At the current liabilities level of US$169.2k liabilities, it appears that the company has been able to meet these obligations given the level of current assets of US$7.3m, with a current ratio of 43.08x. However, anything above 3x is considered high and could mean that SBR has too much idle capital in low-earning investments.
As a high-growth company, it may be beneficial for SBR to have some financial flexibility, hence zero-debt. Since there is also no concerns around SBR’s liquidity needs, this may be its optimal capital structure for the time being. Moving forward, SBR’s financial situation may change. I admit this is a fairly basic analysis for SBR’s financial health. Other important fundamentals need to be considered alongside. I suggest you continue to research Sabine Royalty Trust to get a better picture of the stock by looking at:
- Valuation: What is SBR 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 SBR is currently mispriced by the market.
- Historical Performance: What has SBR’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.