Zero-debt allows substantial financial flexibility, especially for small-cap companies like Foamix Pharmaceuticals Ltd. (NASDAQ:FOMX), 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. Zero-debt can alleviate some risk associated with the company meeting debt obligations, but this doesn’t automatically mean FOMX has outstanding financial strength. I will take you through a few basic checks to assess the financial health of companies with no debt.
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Is FOMX growing fast enough to value financial flexibility over lower cost of capital?
Debt capital generally has lower cost of capital compared to equity funding. 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. The lack of debt on FOMX’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 FOMX is a high-growth company. Opposite to the high growth we were expecting, FOMX’s negative revenue growth of -8.1% hardly justifies opting for zero-debt. If the decline sustains, it may find it hard to raise debt at an acceptable cost.
Can FOMX meet its short-term obligations with the cash in hand?
Since Foamix Pharmaceuticals 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. Looking at FOMX’s US$9.0m in current liabilities, it appears that the company has been able to meet these commitments with a current assets level of US$112m, leading to a 12.4x current account ratio. Having said that, a ratio greater than 3x may be considered high by some.
FOMX 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 FOMX’s liquidity needs, this may be its optimal capital structure for the time being. Going forward, its financial position may change. This is only a rough assessment of financial health, and I’m sure FOMX has company-specific issues impacting its capital structure decisions. You should continue to research Foamix Pharmaceuticals to get a more holistic view of the stock by looking at:
- Future Outlook: What are well-informed industry analysts predicting for FOMX’s future growth? Take a look at our free research report of analyst consensus for FOMX’s outlook.
- Valuation: What is FOMX 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 FOMX 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.