Zero-debt allows substantial financial flexibility, especially for small-cap companies like Geke SA (ATH:PRESD), 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 PRESD 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.
Does PRESD’s growth rate justify its decision for financial flexibility over lower cost of capital?
Debt capital generally has lower cost of capital compared to equity funding. However, the trade-off is debtholders’ higher claim on company assets in the event of liquidation and stringent obligations around capital management. PRESD’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. A single-digit revenue growth of 8.0% for PRESD is considerably low for a small-cap company. More capital can help the business grow faster. If PRESD is not expecting exceptional future growth, then the decision to avoid may cost shareholders in the long term.
Can PRESD pay its short-term liabilities?
Since Geke 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 PRESD’s most recent €3m liabilities, it appears that the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 2.61x. For Hospitality 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.
As a high-growth company, it may be beneficial for PRESD to have some financial flexibility, hence zero-debt. Since there is also no concerns around PRESD’s liquidity needs, this may be its optimal capital structure for the time being. In the future, its financial position may change. Keep in mind I haven’t considered other factors such as how PRESD has been performing in the past. I recommend you continue to research Geke to get a better picture of the stock by looking at:
- Future Outlook: What are well-informed industry analysts predicting for PRESD’s future growth? Take a look at our free research report of analyst consensus for PRESD’s outlook.
- Valuation: What is PRESD 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 PRESD 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 firstname.lastname@example.org.