The direct benefit for Chicago Rivet & Machine Co (NYSEMKT:CVR), 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 CVR will have to adhere to stricter debt covenants and have less financial flexibility. Zero-debt can alleviate some risk associated with the company meeting debt obligations, but this doesn’t automatically mean CVR has outstanding financial strength. I will take you through a few basic checks to assess the financial health of companies with no debt.
Is CVR right in choosing financial flexibility over lower cost of capital?
There are well-known benefits of including debt in capital structure, primarily a lower cost of capital. 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. The lack of debt on CVR’s balance sheet may be because it does not have access to cheap capital, or it may believe this trade-off is not worth it. Choosing financial flexibility over capital returns make sense if CVR is a high-growth company. A single-digit revenue growth of 0.3% for CVR is considerably low for a small-cap company. 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 CVR’s liquid assets cover its short-term commitments?
Given zero long-term debt on its balance sheet, Chicago Rivet & Machine 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. At the current liabilities level of US$3m liabilities, the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 6.39x. Having said that, a ratio greater than 3x may be considered as quite high, and some might argue CVR could be holding too much capital in a low-return investment environment.
Having no debt on the books means CVR 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. Going forward, its financial position may be different. This is only a rough assessment of financial health, and I’m sure CVR has company-specific issues impacting its capital structure decisions. I suggest you continue to research Chicago Rivet & Machine to get a more holistic view of the stock by looking at:
- Future Outlook: What are well-informed industry analysts predicting for CVR’s future growth? Take a look at our free research report of analyst consensus for CVR’s outlook.
- Valuation: What is CVR 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 CVR 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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