The direct benefit for Transat A.T. Inc. (TSE:TRZ), 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 TRZ will have to adhere to stricter debt covenants and have less financial flexibility. While TRZ has no debt on its balance sheet, it doesn’t necessarily mean it exhibits financial strength. I recommend you look at the following hurdles to assess TRZ’s financial health.
Is financial flexibility worth the 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. The lack of debt on TRZ’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 TRZ is a high-growth company. TRZ delivered a negative revenue growth of -0.4%. While its negative growth hardly justifies opting for zero-debt, if the decline sustains, it may find it hard to raise debt at an acceptable cost.
Does TRZ’s liquid assets cover its short-term commitments?
Since Transat A.T 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 CA$836m, the company has been able to meet these obligations given the level of current assets of CA$1.2b, with a current ratio of 1.38x. Generally, for Hospitality companies, this is a reasonable ratio since there’s a sufficient cash cushion without leaving too much capital idle or in low-earning investments.
As a high-growth company, it may be beneficial for TRZ to have some financial flexibility, hence zero-debt. Since there is also no concerns around TRZ’s liquidity needs, this may be its optimal capital structure for the time being. Moving forward, its financial position may be different. Keep in mind I haven’t considered other factors such as how TRZ has been performing in the past. I suggest you continue to research Transat A.T to get a more holistic view of the stock by looking at:
- Future Outlook: What are well-informed industry analysts predicting for TRZ’s future growth? Take a look at our free research report of analyst consensus for TRZ’s outlook.
- Historical Performance: What has TRZ’s returns been like over the past? Go into more detail in the past track record analysis and take a look at the free visual representations of our analysis for more clarity.
- 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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