Zero-debt allows substantial financial flexibility, especially for small-cap companies like Achillion Pharmaceuticals Inc (NASDAQ:ACHN), 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. See our latest analysis for ACHN
Does ACHN’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. 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. ACHN’s absence of debt on its balance sheet may be due to lack of access to cheaper capital, or it may simply believe low cost is not worth sacrificing financial flexibility. However, choosing flexibility over capital returns is logical only if it’s a high-growth company. Opposite to the high growth we were expecting, ACHN’s negative revenue growth of -77.07% hardly justifies opting for zero-debt. If the decline sustains, it may find it hard to raise debt at an acceptable cost.
Can ACHN meet its short-term obligations with the cash in hand?
What about its other commitments such as payments to suppliers and salaries to its employees? In times of adverse events, ACHN may need to liquidate its short-term assets to pay these immediate obligations. We should examine if the company’s cash and short-term investment levels match its current liabilities. Our analysis shows that ACHN is able to meet its upcoming commitments with its cash and other short-term assets, which lessens our concerns for the company’s business operations should any unfavourable circumstances arise.
Are you a shareholder? Given that Achillion Pharmaceuticals is a relatively low-growth company, having no debt on its balance sheet isn’t necessarily the best thing. As an investor, you may want to figure out if there are company-specific reasons for not having any debt, and whether the company needs financial flexibility at this point in time. I suggest you take a look into a future growth analysis to examine the company’s position.
Are you a potential investor? ACHN’s financial health in terms of its liquidity shouldn’t be a concern for potential investors. However, its soft revenue growth could hurt returns, meaning there is some benefit to looking at low-cost funding alternatives. Keep in mind I haven’t considered other factors such as how ACHN has been performing in the past. You should continue your analysis by taking a look at ACHN’s past performance in order to determine for yourself whether its zero-debt position is justified.
To help readers see pass 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.