Is Softcat plc’s (LON:SCT) Balance Sheet Strong Enough To Weather A Storm?
The direct benefit for Softcat plc (LON:SCT), which sports a zero-debt capital structure, to include debt in its capital structure is the reduced cost of capital. However, the trade-off is SCT will have to adhere to stricter debt covenants and have less financial flexibility. Zero-debt can alleviate some risk associated with the company meeting debt obligations, but this doesn’t automatically mean SCT has outstanding financial strength. I will take you through a few basic checks to assess the financial health of companies with no debt.
See our latest analysis for Softcat
Is SCT right in choosing financial flexibility over lower cost of capital?
Debt capital generally has lower cost of capital compared to equity funding. However, the trade-off is debtholders’ higher claim on company assets in the event of liquidation and stringent obligations around capital management. SCT’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. A double-digit revenue growth of 30% is considered relatively high for a small-cap company like SCT. 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.
Does SCT’s liquid assets cover its short-term commitments?
Since Softcat 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. 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 UK£193m liabilities, it appears that the company has been able to meet these commitments with a current assets level of UK£287m, leading to a 1.49x current account ratio. Usually, for IT companies, this is a suitable ratio since there is a bit of a cash buffer without leaving too much capital in a low-return environment.
Next Steps:
SCT is a fast-growing firm, which supports having have zero-debt and financial freedom to continue to ramp up growth. This may mean this is an optimal capital structure for the business, given that it is also meeting its short-term commitment. Moving forward, its financial position may change. Keep in mind I haven’t considered other factors such as how SCT has been performing in the past. You should continue to research Softcat to get a more holistic view of the stock by looking at:
Future Outlook: What are well-informed industry analysts predicting for SCT’s future growth? Take a look at our free research report of analyst consensus for SCT’s outlook.
Valuation: What is SCT 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 SCT is currently mispriced by the market.
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 editorial-team@simplywallst.com.
