Does Zero-Debt Make The RMR Group Inc (RMR) A Financially Strong Company?
Zero-debt allows substantial financial flexibility, especially for small-cap companies like The RMR Group Inc (NASDAQ:RMR), 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. View our latest analysis for RMR Group
Is financial flexibility worth the lower cost of capital?
There are well-known benefits of including debt in capital structure, primarily a lower cost of capital. But the downside of having debt in a company’s balance sheet is the debtholder’s higher claim on its assets in the case of liquidation, as well as stricter capital management requirements. RMR’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. RMR’s revenue growth over the past year is a double-digit 39.21% which is considerably high for a small-cap company. Therefore, the company’s decision to choose financial flexibility is justified as it may need headroom to borrow in the future to sustain high growth.
Does RMR’s liquid assets cover its short-term commitments?
Given zero long-term debt on its balance sheet, RMR Group 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 $20.6M liabilities, it seems that the business has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 4.64x. However, anything about 3x may be excessive, since RMR may be leaving too much capital in low-earning investments.
Next Steps:
Are you a shareholder? As RMR’s revenues are not growing at a fast enough pace, being in a zero-debt position isn’t always optimal. As shareholders, you should try and determine whether this strategy is justified for RMR, and whether the company needs financial flexibility at this point in time. I recommend taking a look into a future growth analysis to properly assess what the market expects for the company moving forward.
Are you a potential investor? RMR’s health in terms of financial liquidity should ease potential investors’ concerns. However, its low sales growth means there’s potential to improve return on capital by taking on some debt and ramp up growth. This is only a rough assessment of financial health, and I’m sure RMR has company-specific issues impacting its capital structure decisions. You should continue your analysis by taking a look at RMR’s past performance in order to determine for yourself whether its zero-debt position is justified.
To help readers see pass 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.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned.
