Zero-debt allows substantial financial flexibility, especially for small-cap companies like Valeura Energy Inc (TSE:VLE), 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 take you through a few basic checks to assess the financial health of companies with no debt. View out our latest analysis for Valeura Energy
Is VLE growing fast enough to value 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 VLE 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 2.13% for VLE is considerably low for a small-cap company. More capital can help the business grow faster. If VLE is not expecting exceptional future growth, then the decision to avoid may cost shareholders in the long term.
Can VLE meet its short-term obligations with the cash in hand?
Given zero long-term debt on its balance sheet, Valeura Energy 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. Looking at VLE’s most recent CA$5.80m liabilities, the company has been able to meet these commitments with a current assets level of CA$64.33m, leading to a 11.09x current account ratio. However, a ratio greater than 3x may be considered as too high, as VLE could be holding too much capital in a low-return investment environment.
VLE 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 VLE’s liquidity needs, this may be its optimal capital structure for the time being. Going forward, VLE’s financial situation may change. I admit this is a fairly basic analysis for VLE’s financial health. Other important fundamentals need to be considered alongside. You should continue to research Valeura Energy to get a more holistic view of the stock by looking at:
- Historical Performance: What has VLE’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.