The direct benefit for Vanda Pharmaceuticals Inc (NASDAQ:VNDA), 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 VNDA will have to adhere to stricter debt covenants and have less financial flexibility. While VNDA has no debt on its balance sheet, it doesn’t necessarily mean it exhibits financial strength. I will take you through a few basic checks to assess the financial health of companies with no debt.
Does VNDA’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. However, the trade-off is debtholders’ higher claim on company assets in the event of liquidation and stringent obligations around capital management. Either VNDA 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. A revenue growth in the teens is not considered high-growth. VNDA’s revenue growth of 13% falls into this range. While its low growth hardly justifies opting for zero-debt, the company may have high growth projects in the pipeline to justify the trade-off.
Does VNDA’s liquid assets cover its short-term commitments?
Since Vanda Pharmaceuticals 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. 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. At the current liabilities level of US$47m liabilities, it seems that the business has been able to meet these obligations given the level of current assets of US$269m, with a current ratio of 5.74x. Having said that, a ratio greater than 3x may be considered as quite high, and some might argue VNDA could be holding too much capital in a low-return investment environment.
Having no debt on the books means VNDA has more financial freedom to keep growing at its current fast rate. This may mean this is an optimal capital structure for the business, given that it is also meeting its short-term commitment. In the future, its financial position may be different. This is only a rough assessment of financial health, and I’m sure VNDA has company-specific issues impacting its capital structure decisions. I suggest you continue to research Vanda Pharmaceuticals to get a more holistic view of the stock by looking at:
- Future Outlook: What are well-informed industry analysts predicting for VNDA’s future growth? Take a look at our free research report of analyst consensus for VNDA’s outlook.
- Valuation: What is VNDA 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 VNDA 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 email@example.com.