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The direct benefit for Neuren Pharmaceuticals Limited (ASX:NEU), 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 NEU will have to adhere to stricter debt covenants and have less financial flexibility. While NEU has no debt on its balance sheet, it doesn’t necessarily mean it exhibits financial strength. I will take you through a few basic checks to assess the financial health of companies with no debt.
Is financial flexibility worth the lower cost of capital?
There are well-known benefits of including debt in capital structure, primarily a lower cost of capital. Though, the trade-offs are that lenders require stricter capital management requirements, in addition to having a higher claim on company assets relative to shareholders. NEU’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. NEU delivered a negative revenue growth of -79%. 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 NEU meet its short-term obligations with the cash in hand?
Since Neuren Pharmaceuticals 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. Looking at NEU’s AU$1.3m in current liabilities, the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 14.49x. However, many consider a ratio above 3x to be high, although this is not necessarily a bad thing.
As a high-growth company, it may be beneficial for NEU 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. Moving forward, NEU’s financial situation may change. Keep in mind I haven’t considered other factors such as how NEU has been performing in the past. I suggest you continue to research Neuren Pharmaceuticals to get a better picture of the stock by looking at:
- Future Outlook: What are well-informed industry analysts predicting for NEU’s future growth? Take a look at our free research report of analyst consensus for NEU’s outlook.
- Historical Performance: What has NEU’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.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.