The direct benefit for Liquidity Services Inc (NASDAQ:LQDT), 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 LQDT 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 go over a basic overview of the stock’s financial health, which I believe provides a ballpark estimate of their financial health status. View our latest analysis for Liquidity Services
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 LQDT 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, LQDT’s negative revenue growth of -20.31% hardly justifies opting for zero-debt. If the decline sustains, it may find it hard to raise debt at an acceptable cost.
Can LQDT meet its short-term obligations with the cash in hand?
Since Liquidity Services 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 $85.5M liabilities, it appears that the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 2.16x. Usually, for internet software and services companies, this is a suitable ratio as there’s enough of a cash buffer without holding too capital in low return investments.
Are you a shareholder? LQDT’s soft top-line growth means not having any low-cost debt funding may not be optimal for the business. Shareholders should understand why the company isn’t opting for cheaper cost of capital to fund future growth, and whether the company needs financial flexibility at this point in time. I suggest you take a look into a future growth analysis to examine the company’s position.
Are you a potential investor? LQDT’s financial health in terms of its liquidity shouldn’t be a concern for potential investors. However, its low sales growth could hurt returns, meaning there is some benefit to looking at low-cost funding alternatives. I admit this is a fairly basic analysis for LQDT’s financial health. Other important fundamentals need to be considered alongside. You should continue your analysis by taking a look at LQDT’s past performance to figure out LQDT’s financial health position.
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.