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The direct benefit for Aqualis ASA (OB:AQUA), 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 AQUA will have to adhere to stricter debt covenants and have less financial flexibility. 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 go over a basic overview of the stock’s financial health, which I believe provides a ballpark estimate of their financial health status.
Is AQUA 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. 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 AQUA 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. AQUA’s revenue growth over the past year is a double-digit 24% which is considerably high for a small-cap company. So, it is acceptable that the company is opting for a zero-debt capital structure currently as it may need to raise debt to fuel expansion in the future.
Can AQUA meet its short-term obligations with the cash in hand?
Given zero long-term debt on its balance sheet, Aqualis 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 AQUA’s US$4.5m in current liabilities, it seems that the business has been able to meet these obligations given the level of current assets of US$17m, with a current ratio of 3.87x. However, a ratio greater than 3x may be considered high by some.
Having no debt on the books means AQUA has more financial freedom to keep growing at its current fast rate. Since there is also no concerns around AQUA’s liquidity needs, this may be its optimal capital structure for the time being. Going forward, AQUA’s financial situation may change. This is only a rough assessment of financial health, and I’m sure AQUA has company-specific issues impacting its capital structure decisions. I recommend you continue to research Aqualis to get a better picture of the stock by looking at:
- Valuation: What is AQUA 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 AQUA is currently mispriced by the market.
- Historical Performance: What has AQUA’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.
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.