Renk Aktiengesellschaft (FRA:ZAR), 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 ZAR will have to follow strict debt obligations which will reduce its financial flexibility. While ZAR has no debt on its balance sheet, it doesn’t necessarily mean it exhibits financial strength. I will go over a basic overview of the stock’s financial health, which I believe provides a ballpark estimate of their financial health status.
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. ZAR’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. Opposite to the high growth we were expecting, ZAR’s negative revenue growth of -6.1% hardly justifies opting for zero-debt. If the decline sustains, it may find it hard to raise debt at an acceptable cost.
Can ZAR pay its short-term liabilities?
Given zero long-term debt on its balance sheet, Renk has no solvency issues, which is 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 €188m, it appears that the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 2.59x. For Auto Components companies, this ratio is within a sensible range since there’s a sufficient cash cushion without leaving too much capital idle or in low-earning investments.
ZAR is a fast-growing firm, which supports having have zero-debt and financial freedom to continue to ramp up growth. Since there is also no concerns around ZAR’s liquidity needs, this may be its optimal capital structure for the time being. In the future, its financial position may change. I admit this is a fairly basic analysis for ZAR’s financial health. Other important fundamentals need to be considered alongside. You should continue to research Renk to get a more holistic view of the stock by looking at:
- Future Outlook: What are well-informed industry analysts predicting for ZAR’s future growth? Take a look at our free research report of analyst consensus for ZAR’s outlook.
- Historical Performance: What has ZAR’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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