Zero-debt allows substantial financial flexibility, especially for small-cap companies like Insteel Industries Inc (NASDAQ:IIIN), 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 IIIN has no debt on its balance sheet, it doesn’t necessarily mean it exhibits financial strength. I will take you through a few basic checks to assess the financial health of companies with no debt. View our latest analysis for Insteel Industries
Is IIIN right in choosing financial flexibility over lower cost of capital?
There are well-known benefits of including debt in capital structure, primarily a lower cost of capital. However, the trade-off is debtholders’ higher claim on company assets in the event of liquidation and stringent obligations around capital management. Either IIIN 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, IIIN’s negative revenue growth of -7.09% hardly justifies opting for zero-debt. If the decline sustains, it may find it hard to raise debt at an acceptable cost.
Can IIIN meet its short-term obligations with the cash in hand?
Since Insteel Industries 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. Looking at IIIN’s most recent $42.3M liabilities, it seems that the business has been able to meet these commitments with a current assets level of $160.2M, leading to a 3.79x current account ratio. However, a ratio greater than 3x may be considered as too high, as IIIN could be holding too much capital in a low-return investment environment.
Given that Insteel Industries is a relatively low-growth company, not taking advantage of lower cost debt may not be the best strategy. As an investor, you may want to figure out if there are company-specific reasons for not having any debt, and why financial flexibility is needed at this stage in its business cycle. I admit this is a fairly basic analysis for IIIN’s financial health. Other important fundamentals need to be considered alongside. I suggest you continue to research Insteel Industries to get a better picture of the stock by looking at:
- 1. Future Outlook: What are well-informed industry analysts predicting for IIIN’s future growth? Take a look at our free research report of analyst consensus for IIIN’s outlook.
- 2. Valuation: What is IIIN 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 IIIN is currently mispriced by the market.
- 3. 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 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.