Zero-debt allows substantial financial flexibility, especially for small-cap companies like Vanda Pharmaceuticals Inc. (NASDAQ:VNDA), 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 VNDA has outstanding financial strength. I recommend you look at the following hurdles to assess VNDA’s financial health.
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Does VNDA’s growth rate justify its decision for financial flexibility over lower cost of capital?
Debt capital generally has lower cost of capital compared to equity funding. 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 16% 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.
Can VNDA meet its short-term obligations with the cash in hand?
Given zero long-term debt on its balance sheet, Vanda Pharmaceuticals has no solvency issues, which is 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. Looking at VNDA’s US$46m in current liabilities, the company has been able to meet these commitments with a current assets level of US$279m, leading to a 6.03x current account ratio. Having said that, a ratio greater than 3x may be considered by some to be quite high, however this is not necessarily a negative for the company.
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. Keep in mind I haven’t considered other factors such as how VNDA has been performing in the past. You should 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 firstname.lastname@example.org.