Culp Inc (NYSE:CULP), 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 CULP 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 CULP has outstanding financial strength. I will take you through a few basic checks to assess the financial health of companies with no debt.
Does CULP’s growth rate justify its decision for 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 CULP’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 CULP is a high-growth company. Opposite to the high growth we were expecting, CULP’s negative revenue growth of -0.6% hardly justifies opting for zero-debt. If the decline sustains, it may find it hard to raise debt at an acceptable cost.
Does CULP’s liquid assets cover its short-term commitments?
Since Culp 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. But another important aspect of financial health is liquidity: the company’s ability to meet short-term obligations, including payments to suppliers and employees. With current liabilities at US$36m, it seems that the business has been able to meet these commitments with a current assets level of US$119m, leading to a 3.27x current account ratio. Having said that, 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 CULP to have some financial flexibility, hence zero-debt. Since there is also no concerns around CULP’s liquidity needs, this may be its optimal capital structure for the time being. Moving forward, CULP’s financial situation may change. This is only a rough assessment of financial health, and I’m sure CULP has company-specific issues impacting its capital structure decisions. I suggest you continue to research Culp to get a better picture of the stock by looking at:
- Future Outlook: What are well-informed industry analysts predicting for CULP’s future growth? Take a look at our free research report of analyst consensus for CULP’s outlook.
- Valuation: What is CULP 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 CULP 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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