Realm Therapeutics Plc (LON:RLM), 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 RLM will have to follow strict debt obligations which will reduce its financial flexibility. While RLM has no debt on its balance sheet, it doesn’t necessarily mean it exhibits financial strength. I recommend you look at the following hurdles to assess RLM’s financial health.
Is RLM growing fast enough to value financial flexibility over 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. The lack of debt on RLM’s balance sheet may be because it does not have access to cheap capital, or it may believe this trade-off is not worth it. Choosing financial flexibility over capital returns make sense if RLM is a high-growth company. RLM delivered a negative revenue growth of -55%. While its negative growth hardly justifies opting for zero-debt, if the decline sustains, it may find it hard to raise debt at an acceptable cost.
Can RLM pay its short-term liabilities?
Given zero long-term debt on its balance sheet, Realm Therapeutics 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$2.5m, the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 10.05x. However, a ratio above 3x may be considered excessive by some investors.
As a high-growth company, it may be beneficial for RLM to have some financial flexibility, hence zero-debt. This may mean this is an optimal capital structure for the business, given that it is also meeting its short-term commitment. Going forward, its financial position may change. This is only a rough assessment of financial health, and I’m sure RLM has company-specific issues impacting its capital structure decisions. I recommend you continue to research Realm Therapeutics to get a better picture of the stock by looking at:
- Historical Performance: What has RLM’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.
- 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.
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