The direct benefit for Realm Therapeutics Plc (AIM:RLM), 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 RLM will have to adhere to stricter debt covenants and have less financial flexibility. While RLM 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 RLM
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. 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 RLM 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. RLM delivered a negative revenue growth of -29.67%. 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?
Since Realm Therapeutics 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. With current liabilities at $3.2M liabilities, the company has been able to meet these obligations given the level of current assets of $21.8M, with a current ratio of 6.81x. However, a ratio greater than 3x may be considered as too high, as RLM could be holding too much capital in a low-return investment environment.
Are you a shareholder? Having no debt on the books means RLM has more financial freedom to keep growing at its current fast rate. Since there is also no concerns around RLM’s liquidity needs, this may be its optimal capital structure for the time being. Going forward, its financial position may change. I suggest keeping on top of market expectations for RLM’s future growth.
Are you a potential investor? RLM’s high growth makes financial flexibility an attractive option. Furthermore, its high liquidity means the company should continue to operate smoothly in the case of adverse events. In order to build your conviction in the stock, you need to further examine RLM’s track record. You should continue your analysis by taking a look at RLM’s past performance in order to determine for yourself whether its zero-debt position is justified.