Xunlei Limited (NASDAQ:XNET), 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 XNET will have to follow strict debt obligations which will reduce its financial flexibility. Zero-debt can alleviate some risk associated with the company meeting debt obligations, but this doesn’t automatically mean XNET has outstanding financial strength. 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 Xunlei
Is XNET growing fast enough to value financial flexibility over lower cost of capital?
There are well-known benefits of including debt in capital structure, primarily a lower cost of capital. But the downside of having debt in a company’s balance sheet is the debtholder’s higher claim on its assets in the case of liquidation, as well as stricter capital management requirements. XNET’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 20.46% is considered relatively high for a small-cap company like XNET. Therefore, the company’s decision to choose financial flexibility is justified as it may need headroom to borrow in the future to sustain high growth.
Can XNET meet its short-term obligations with the cash in hand?
Since Xunlei 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 $93.4M liabilities, the company has been able to meet these obligations given the level of current assets of $412.3M, with a current ratio of 4.41x. Though, anything above 3x is considered high and could mean that XNET has too much idle capital in low-earning investments.
Are you a shareholder? XNET’s soft top-line growth means having no debt on its balance sheet isn’t necessarily the best thing. 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 suggest you take a look into a future growth analysis to examine the company’s position.
Are you a potential investor? XNET’s health in terms of financial liquidity should ease potential investors’ concerns. However, its low sales growth could hurt returns, meaning there is some benefit to looking at low-cost funding alternatives. Keep in mind I haven’t considered other factors such as how XNET has been performing in the past. I encourage you to continue your research by taking a look at XNET’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.