The direct benefit for Cross Timbers Royalty Trust (NYSE:CRT), 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 CRT will have to adhere to stricter debt covenants and have less financial flexibility. 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 will take you through a few basic checks to assess the financial health of companies with no debt. Check out our latest analysis for Cross Timbers Royalty Trust
Is CRT growing fast enough to value 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. Either CRT 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. Opposite to the high growth we were expecting, CRT’s negative revenue growth of -14.85% hardly justifies opting for zero-debt. If the decline sustains, it may find it hard to raise debt at an acceptable cost.
Can CRT pay its short-term liabilities?
Given zero long-term debt on its balance sheet, Cross Timbers Royalty Trust 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. With current liabilities at $1.5M liabilities, it seems that the business has not been able to meet these commitments with a current assets level of $1.5M, leading to a 1x current account ratio. which is under the appropriate industry ratio of 3x.
Are you a shareholder? Given that Cross Timbers Royalty Trust is a relatively low-growth company, being in a zero-debt position isn’t always optimal. As an investor, you may want to figure out if there are company-specific reasons for not having any debt, especially when liquidity may also be an issue. 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? CRT low revenue growth means the cost of financial flexibility may not be worth the benefit. Furthermore, its lack of liquidity means the company may be pressed to meet its short-term obligations. I encourage you to continue your research by taking a look at CRT’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.