The direct benefit for Alpha Pro Tech, Ltd. (NYSEMKT:APT), 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 APT 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 take you through a few basic checks to assess the financial health of companies with no debt.
Is financial flexibility worth the 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. The lack of debt on APT’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 APT is a high-growth company. APT’s revenue growth over the past year is a single-digit 3.8% which is relatively low for a small-cap company. More capital can help the business grow faster. If APT is not expecting exceptional future growth, then the decision to avoid may cost shareholders in the long term.
Can APT meet its short-term obligations with the cash in hand?
Given zero long-term debt on its balance sheet, Alpha Pro Tech 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 US$1.7m, it seems that the business has been able to meet these obligations given the level of current assets of US$26m, with a current ratio of 15.26x. However, a ratio above 3x may be considered excessive by some investors, yet this is not usually a major negative for a company.
APT 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 APT’s liquidity needs, this may be its optimal capital structure for the time being. Moving forward, APT’s financial situation may change. This is only a rough assessment of financial health, and I’m sure APT has company-specific issues impacting its capital structure decisions. I suggest you continue to research Alpha Pro Tech to get a better picture of the stock by looking at:
- Future Outlook: What are well-informed industry analysts predicting for APT’s future growth? Take a look at our free research report of analyst consensus for APT’s outlook.
- Valuation: What is APT 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 APT 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 firstname.lastname@example.org.