The Cato Corporation (NYSE:CATO), which has zero-debt on its balance sheet, can maximize capital returns by increasing debt due to its lower cost of capital. However, the trade-off is CATO will have to follow strict debt obligations which will reduce its financial flexibility. Zero-debt can alleviate some risk associated with the company meeting debt obligations, but this doesn’t automatically mean CATO has outstanding financial strength. I will go over a basic overview of the stock’s financial health, which I believe provides a ballpark estimate of their financial health status.
Is CATO right in choosing 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. CATO’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, CATO’s negative revenue growth of -3.0% hardly justifies opting for zero-debt. If the decline sustains, it may find it hard to raise debt at an acceptable cost.
Can CATO pay its short-term liabilities?
Given zero long-term debt on its balance sheet, Cato 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. With current liabilities at US$138m, the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 2.73x. Generally, for Specialty Retail companies, this is a reasonable ratio as there’s enough of a cash buffer without holding too much capital in low return investments.
As a high-growth company, it may be beneficial for CATO to have some financial flexibility, hence zero-debt. Since there is also no concerns around CATO’s liquidity needs, this may be its optimal capital structure for the time being. Going forward, its financial position may be different. I admit this is a fairly basic analysis for CATO’s financial health. Other important fundamentals need to be considered alongside. I suggest you continue to research Cato to get a better picture of the stock by looking at:
- Future Outlook: What are well-informed industry analysts predicting for CATO’s future growth? Take a look at our free research report of analyst consensus for CATO’s outlook.
- Valuation: What is CATO 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 CATO 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.
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