Zero-debt allows substantial financial flexibility, especially for small-cap companies like Karelia Tobacco Company Inc (ATH:KARE), 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 recommend you look at the following hurdles to assess KARE’s financial health.
Is KARE right in choosing 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 KARE 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 3.0% for KARE is considerably low for a small-cap company. While its low growth hardly justifies opting for zero-debt, the company may have high growth projects in the pipeline to justify the trade-off.
Does KARE’s liquid assets cover its short-term commitments?
Given zero long-term debt on its balance sheet, Karelia Tobacco Company has no solvency issues, which is 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 KARE’s €95m in current liabilities, the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 5.12x. However, many consider a ratio above 3x to be high, although this is not necessarily a bad thing.
KARE 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 KARE’s liquidity needs, this may be its optimal capital structure for the time being. In the future, its financial position may change. I admit this is a fairly basic analysis for KARE’s financial health. Other important fundamentals need to be considered alongside. I suggest you continue to research Karelia Tobacco Company to get a better picture of the stock by looking at:
- Future Outlook: What are well-informed industry analysts predicting for KARE’s future growth? Take a look at our free research report of analyst consensus for KARE’s outlook.
- Valuation: What is KARE 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 KARE 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 email@example.com.