Silicom Ltd (NASDAQ:SILC): Financial Strength Analysis
Zero-debt allows substantial financial flexibility, especially for small-cap companies like Silicom Ltd (NASDAQ:SILC), 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 SILC’s financial health. See our latest analysis for Silicom
Is SILC 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. The lack of debt on SILC’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 SILC is a high-growth company. A double-digit revenue growth of 21.28% is considered relatively high for a small-cap company like SILC. So, it is acceptable that the company is opting for a zero-debt capital structure currently as it may need to raise debt to fuel expansion in the future.
Can SILC pay its short-term liabilities?
Given zero long-term debt on its balance sheet, Silicom 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. At the current liabilities level of $18.0M liabilities, it seems that the business has been able to meet these obligations given the level of current assets of $103.3M, with a current ratio of 5.75x. However, anything above 3x is considered high and could mean that SILC has too much idle capital in low-earning investments.
Next Steps:
Are you a shareholder? As SILC’s revenues are not growing at a fast enough pace, having no debt on its balance sheet isn’t necessarily the best thing. As an investor, you may want to figure out if there are company-specific reasons for not having any debt, and whether the company needs financial flexibility at this point in time. I recommend taking a look into a future growth analysis to account for what the market expects for the company moving forward.
Are you a potential investor? SILC’s management of short term liabilities is strong. But, its soft 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 SILC’s financial health. Other important fundamentals need to be considered alongside. You should continue your analysis by taking a look at SILC’s past performance to conclude on SILC’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.
