Zero-debt allows substantial financial flexibility, especially for small-cap companies like Read-Gene SA (WSE:RDG), 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 will take you through a few basic checks to assess the financial health of companies with no debt.
Is RDG right in choosing 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 RDG 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. Opposite to the high growth we were expecting, RDG’s negative revenue growth of -33% hardly justifies opting for zero-debt. If the decline sustains, it may find it hard to raise debt at an acceptable cost.
Does RDG’s liquid assets cover its short-term commitments?
Given zero long-term debt on its balance sheet, Read-Gene 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. With current liabilities at zł10m, it appears that the company may not have an easy time meeting these commitments with a current assets level of zł5m, leading to a current ratio of 0.53x.
Having no debt on the books means RDG has more financial freedom to keep growing at its current fast rate. Though, the company’s low liquidity lowers our conviction around meeting short-term obligations. Some level of low-cost debt funding could help meet these needs. Moving forward, its financial position may change. This is only a rough assessment of financial health, and I’m sure RDG has company-specific issues impacting its capital structure decisions. I recommend you continue to research Read-Gene to get a better picture of the stock by looking at:
- Valuation: What is RDG 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 RDG is currently mispriced by the market.
- Historical Performance: What has RDG’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 email@example.com.