The direct benefit for Aeterna Zentaris Inc (TSE:AEZS), 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 AEZS will have to adhere to stricter debt covenants and have less financial flexibility. While AEZS 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.
See our latest analysis for Aeterna Zentaris
Does AEZS’s growth rate justify its decision for financial flexibility over lower cost of capital?
There are well-known benefits of including debt in capital structure, primarily a lower cost of capital. But the downside of having debt in a company’s balance sheet is the debtholder’s higher claim on its assets in the case of liquidation, as well as stricter capital management requirements. Either AEZS 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. AEZS delivered a strikingly high triple-digit revenue growth over the past year, therefore the company’s decision to choose financial flexibility is justified as it may need headroom to borrow in the future to sustain high growth.
Can AEZS pay its short-term liabilities?
Since Aeterna Zentaris 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 US$6m, it appears that the company has been able to meet these commitments with a current assets level of US$23m, leading to a 4.04x current account ratio. Having said that, a ratio greater than 3x may be considered as quite high, and some might argue AEZS could be holding too much capital in a low-return investment environment.
Next Steps:
Having no debt on the books means AEZS has more financial freedom to keep growing at its current fast rate. Since there is also no concerns around AEZS’s liquidity needs, this may be its optimal capital structure for the time being. Moving forward, its financial position may be different. Keep in mind I haven’t considered other factors such as how AEZS has been performing in the past. You should continue to research Aeterna Zentaris to get a better picture of the stock by looking at:
- Future Outlook: What are well-informed industry analysts predicting for AEZS’s future growth? Take a look at our free research report of analyst consensus for AEZS’s outlook.
- Valuation: What is AEZS 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 AEZS 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.