Zero-debt allows substantial financial flexibility, especially for small-cap companies like Alpha Pro Tech, Ltd. (NYSEMKT:APT), 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 APT’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 APT 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 single-digit revenue growth of 3.8% for APT is considerably 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.
Does APT’s liquid assets cover its short-term commitments?
Since Alpha Pro Tech 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. With current liabilities at US$1.7m, it seems that the business has been able to meet these commitments with a current assets level of US$26m, leading to a 15.26x current account ratio. However, many consider a ratio above 3x to be high, although this is not necessarily a bad thing.
As a high-growth company, it may be beneficial for APT to have some financial flexibility, hence zero-debt. Since there is also no concerns around APT’s liquidity needs, this may be its optimal capital structure for the time being. Moving forward, its financial position may change. I admit this is a fairly basic analysis for APT’s financial health. Other important fundamentals need to be considered alongside. You should 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.
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