The direct benefit for RADA Electronic Industries Ltd (NASDAQ:RADA), which sports a zero-debt capital structure, to include debt in its capital structure is the reduced cost of capital. However, the trade-off is RADA will have to adhere to stricter debt covenants and have less financial flexibility. 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 recommend you look at the following hurdles to assess RADA’s financial health.
Does RADA’s growth rate justify its decision for financial flexibility over 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. RADA’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. RADA’s revenue growth over the past year is an impressively high double-digit 63.3%. Therefore, the company’s decision to choose financial flexibility is justified as it may need headroom to borrow in the future to sustain high growth.
Can RADA meet its short-term obligations with the cash in hand?
Since RADA Electronic Industries 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 US$5.0m liabilities, it seems that the business has been able to meet these obligations given the level of current assets of US$31.4m, with a current ratio of 6.25x. Though, anything about 3x may be excessive, since RADA may be leaving too much capital in low-earning investments.
As a high-growth company, it may be beneficial for RADA to have some financial flexibility, hence zero-debt. This may mean this is an optimal capital structure for the business, given that it is also meeting its short-term commitment. Going forward, its financial position may be different. This is only a rough assessment of financial health, and I’m sure RADA has company-specific issues impacting its capital structure decisions. You should continue to research RADA Electronic Industries to get a more holistic view of the stock by looking at:
- Historical Performance: What has RADA’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.
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