Zero-debt allows substantial financial flexibility, especially for small-cap companies like Redbubble Limited (ASX:RBL), 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.
Is financial flexibility worth the lower cost of capital?
Debt funding can be cheaper than issuing new equity due to lower interest cost on debt. However, the trade-off is debtholders’ higher claim on company assets in the event of liquidation and stringent obligations around capital management. Either RBL 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. A double-digit revenue growth of 30% is considered relatively high for a small-cap company like RBL. So, it is acceptable that the company is opting for a zero-debt capital structure currently as it may need to raise debt to fuel expansion in the future.
Can RBL pay its short-term liabilities?
Since Redbubble 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. Looking at RBL’s most recent AU$25m liabilities, it appears that the company may not be able to easily meet these obligations given the level of current assets of AU$24m, with a current ratio of 0.98x.
RBL is a fast-growing firm, which supports having have zero-debt and financial freedom to continue to ramp up growth. Though, the company’s low liquidity reduces our confidence around meeting short-term commitments. Some level of low-cost debt funding could help meet these needs. In the future, its financial position may be different. Keep in mind I haven’t considered other factors such as how RBL has been performing in the past. I suggest you continue to research Redbubble to get a more holistic view of the stock by looking at:
- Future Outlook: What are well-informed industry analysts predicting for RBL’s future growth? Take a look at our free research report of analyst consensus for RBL’s outlook.
- Valuation: What is RBL 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 RBL 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.