QinetiQ Group plc (LON:QQ.), 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 QQ. 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 QQ. has outstanding financial strength. I recommend you look at the following hurdles to assess QQ.’s financial health.
Is QQ. 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. However, the trade-off is debtholders’ higher claim on company assets in the event of liquidation and stringent obligations around capital management. Either QQ. 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. A single-digit revenue growth of 6.4% for QQ. is considerably low for a small-cap company. More capital can help the business grow faster. If QQ. is not expecting exceptional future growth, then the decision to avoid may cost shareholders in the long term.
Can QQ. pay its short-term liabilities?
Since QinetiQ Group 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. With current liabilities at UK£352m, it seems that the business has been able to meet these obligations given the level of current assets of UK£461m, with a current ratio of 1.31x. For Aerospace & Defense companies, this ratio is within a sensible range as there’s enough of a cash buffer without holding too much capital in low return investments.
QQ. is a fast-growing firm, which supports having have zero-debt and financial freedom to continue to ramp up growth. Since there is also no concerns around QQ.’s liquidity needs, this may be its optimal capital structure for the time being. Moving forward, its financial position may be different. This is only a rough assessment of financial health, and I’m sure QQ. has company-specific issues impacting its capital structure decisions. I recommend you continue to research QinetiQ Group to get a better picture of the stock by looking at:
- Future Outlook: What are well-informed industry analysts predicting for QQ.’s future growth? Take a look at our free research report of analyst consensus for QQ.’s outlook.
- Valuation: What is QQ. 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 QQ. is currently mispriced by the market.
- 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 past 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.
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