The direct benefit for Acceleron Pharma Inc. (NASDAQ:XLRN), 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 XLRN will have to adhere to stricter debt covenants and have less financial flexibility. 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.
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. Either XLRN does not have access to cheap capital, or it may believe this trade-off is not worth it. This makes sense only if the company has a competitive edge and is growing fast off its equity capital. XLRN’s revenue growth over the past year is a single-digit 5.6% which is relatively low for a small-cap company. More capital can help the business grow faster. If XLRN is not expecting exceptional future growth, then the decision to avoid may cost shareholders in the long term.
Can XLRN meet its short-term obligations with the cash in hand?
Since Acceleron Pharma 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$15m, it seems that the business has been able to meet these commitments with a current assets level of US$318m, leading to a 21.68x current account ratio. However, a ratio above 3x may be considered excessive by some investors.
XLRN is a fast-growing firm, which supports having have zero-debt and financial freedom to continue to ramp up growth. 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 change. Keep in mind I haven’t considered other factors such as how XLRN has been performing in the past. I recommend you continue to research Acceleron Pharma to get a better picture of the stock by looking at:
- Future Outlook: What are well-informed industry analysts predicting for XLRN’s future growth? Take a look at our free research report of analyst consensus for XLRN’s outlook.
- Valuation: What is XLRN 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 XLRN 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.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at firstname.lastname@example.org.