Zero-debt allows substantial financial flexibility, especially for small-cap companies like rhipe Limited (ASX:RHP), as the company does not have to adhere to strict debt covenants. However, it also faces higher cost of capital given interest cost is generally lower than equity. 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.
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Is RHP right in choosing financial flexibility over lower cost of capital?
Debt capital generally has lower cost of capital compared to equity funding. 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. Either RHP 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. RHP’s revenue growth over the past year is a double-digit 25% which is considerably high for a small-cap company. So, it is acceptable that the company is opting for a zero-debt capital structure currently as it may need to raise debt to fuel expansion in the future.
Can RHP pay its short-term liabilities?
Since rhipe 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. But another important aspect of financial health is liquidity: the company’s ability to meet short-term obligations, including payments to suppliers and employees. Looking at RHP’s AU$47m in current liabilities, it seems that the business has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 1.44x. For IT companies, this ratio is within a sensible range since there’s a sufficient cash cushion without leaving too much capital idle or in low-earning investments.
Next Steps:
As a high-growth company, it may be beneficial for RHP to have some financial flexibility, hence zero-debt. Since there is also no concerns around RHP’s liquidity needs, this may be its optimal capital structure for the time being. Moving forward, its financial position may be different. I admit this is a fairly basic analysis for RHP’s financial health. Other important fundamentals need to be considered alongside. You should continue to research rhipe to get a better picture of the stock by looking at:
- Future Outlook: What are well-informed industry analysts predicting for RHP’s future growth? Take a look at our free research report of analyst consensus for RHP’s outlook.
- Valuation: What is RHP 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 RHP 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.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.