Compugen Ltd (NASDAQ:CGEN), 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 CGEN will have to follow strict debt obligations which will reduce its financial flexibility. While CGEN has no debt on its balance sheet, it doesn’t necessarily mean it exhibits financial strength. I will take you through a few basic checks to assess the financial health of companies with no debt. Check out our latest analysis for Compugen
Is CGEN right in choosing financial flexibility over lower cost of capital?
There are well-known benefits of including debt in capital structure, primarily a lower cost of capital. Though, the trade-offs are that lenders require stricter capital management requirements, in addition to having a higher claim on company assets relative to shareholders. Either CGEN 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. Opposite to the high growth we were expecting, CGEN’s negative revenue growth of -92.33% hardly justifies opting for zero-debt. If the decline sustains, it may find it hard to raise debt at an acceptable cost.
Can CGEN meet its short-term obligations with the cash in hand?
Since Compugen 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. At the current liabilities level of $4.7M liabilities, the company has been able to meet these obligations given the level of current assets of $62.7M, with a current ratio of 13.22x. However, anything above 3x is considered high and could mean that CGEN has too much idle capital in low-earning investments.
Are you a shareholder? As CGEN’s revenues are not growing at a fast enough pace, not having any low-cost debt funding may not be optimal for the business. Shareholders should understand why the company isn’t opting for cheaper cost of capital to fund future growth, and whether the company needs financial flexibility at this point in time. I recommend taking a look into a future growth analysis to examine what the market expects for the company moving forward.
Are you a potential investor? In terms of meeting is short term obligations, there’s nothing to worry about for CGEN. But, its soft revenue 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 CGEN has company-specific issues impacting its capital structure decisions. I encourage you to continue your research by taking a look at CGEN’s past performance to figure out CGEN’s financial health position.
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.