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Zero-debt allows substantial financial flexibility, especially for small-cap companies like Outdoorzy S.A. (WSE:OUT), 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.
Does OUT’s growth rate justify its decision for 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 OUT 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, OUT’s negative revenue growth of -1.7% hardly justifies opting for zero-debt. If the decline sustains, it may find it hard to raise debt at an acceptable cost.
Can OUT meet its short-term obligations with the cash in hand?
Since Outdoorzy 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 zł2.0m, it appears that the company has been able to meet these commitments with a current assets level of zł3.5m, leading to a 1.73x current account ratio. Usually, for Online Retail companies, this is a suitable ratio since there is a bit of a cash buffer without leaving too much capital in a low-return environment.
As a high-growth company, it may be beneficial for OUT to have some financial flexibility, hence zero-debt. Since there is also no concerns around OUT’s liquidity needs, this may be its optimal capital structure for the time being. Going forward, OUT’s financial situation may change. I admit this is a fairly basic analysis for OUT’s financial health. Other important fundamentals need to be considered alongside. You should continue to research Outdoorzy to get a better picture of the stock by looking at:
- Future Outlook: What are well-informed industry analysts predicting for OUT’s future growth? Take a look at our free research report of analyst consensus for OUT’s outlook.
- Historical Performance: What has OUT’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.