Zero-debt allows substantial financial flexibility, especially for small-cap companies like Emmerson Realty SA (WSE:EMM), 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. Zero-debt can alleviate some risk associated with the company meeting debt obligations, but this doesn’t automatically mean EMM has outstanding financial strength. I will take you through a few basic checks to assess the financial health of companies with no debt.
Is EMM growing fast enough to value financial flexibility over lower cost of capital?
Debt capital generally has lower cost of capital compared to equity funding. 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. The lack of debt on EMM’s balance sheet may be because it does not have access to cheap capital, or it may believe this trade-off is not worth it. Choosing financial flexibility over capital returns make sense if EMM is a high-growth company. A single-digit revenue growth of 7.6% for EMM is considerably low for a small-cap company. More capital can help the business grow faster. If EMM is not expecting exceptional future growth, then the decision to avoid may cost shareholders in the long term.
Can EMM pay its short-term liabilities?
Since Emmerson Realty 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 zł4m, it appears that the company has been able to meet these obligations given the level of current assets of zł4m, with a current ratio of 1.05x. Usually, for Real Estate companies, this is a suitable ratio since there’s a sufficient cash cushion without leaving too much capital idle or in low-earning investments.
Having no debt on the books means EMM has more financial freedom to keep growing at its current fast rate. Since there is also no concerns around EMM’s liquidity needs, this may be its optimal capital structure for the time being. In the future, EMM’s financial situation may change. This is only a rough assessment of financial health, and I’m sure EMM has company-specific issues impacting its capital structure decisions. I suggest you continue to research Emmerson Realty to get a better picture of the stock by looking at:
- Historical Performance: What has EMM’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.
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