SandRidge Mississippian Trust I (NYSE:SDT), which has zero-debt on its balance sheet, can maximize capital returns by increasing debt due to its lower cost of capital. However, the trade-off is SDT will have to follow strict debt obligations which will reduce its 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. See our latest analysis for SandRidge Mississippian Trust I
Is SDT 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 SDT 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, SDT’s negative revenue growth of -52.31% hardly justifies opting for zero-debt. If the decline sustains, it may find it hard to raise debt at an acceptable cost.
Does SDT’s liquid assets cover its short-term commitments?
Given zero long-term debt on its balance sheet, SandRidge Mississippian Trust I has no solvency issues, which is 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 US$0 liabilities, it appears that the company has not maintained a sufficient level of current assets to meet its obligations, with the current ratio last standing at x, which is below the prudent industry ratio of 3x.
Since SDT is a low-growth stock in terms of its revenues, not taking advantage of lower cost debt may not be the best strategy. Shareholders should understand why the company isn’t opting for cheaper cost of capital to fund future growth, especially if meeting short-term obligations could also bring about issues. This is only a rough assessment of financial health, and I’m sure SDT has company-specific issues impacting its capital structure decisions. I recommend you continue to research SandRidge Mississippian Trust I to get a more holistic view of the stock by looking at:
1. Valuation: What is SDT 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 SDT is currently mispriced by the market.
2. Historical Performance: What has SDT’s returns been like over the past? Go into more detail in the past track record analysis and take a look at the free visual representations of our analysis for more clarity.
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.