Zero-debt allows substantial financial flexibility, especially for small-cap companies like Pure Cycle Corporation (NASDAQ:PCYO), 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 go over a basic overview of the stock’s financial health, which I believe provides a ballpark estimate of their financial health status.
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Is PCYO right in choosing 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 PCYO’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 PCYO is a high-growth company. PCYO delivered a strikingly high triple-digit revenue growth over the past year, 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.
Does PCYO’s liquid assets cover its short-term commitments?
Since Pure Cycle 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 PCYO’s US$2.1m in current liabilities, it seems that the business has been able to meet these obligations given the level of current assets of US$28m, with a current ratio of 13.59x. However, a ratio greater than 3x may be considered by some to be quite high, however this is not necessarily a negative for the company.
As a high-growth company, it may be beneficial for PCYO to have some financial flexibility, hence zero-debt. Since there is also no concerns around PCYO’s liquidity needs, this may be its optimal capital structure for the time being. Moving forward, its financial position may be different. I admit this is a fairly basic analysis for PCYO’s financial health. Other important fundamentals need to be considered alongside. I suggest you continue to research Pure Cycle to get a better picture of the stock by looking at:
- Historical Performance: What has PCYO’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.
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 email@example.com.