Zero-debt allows substantial financial flexibility, especially for small-cap companies like Valeura Energy Inc (TSE:VLE), 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 recommend you look at the following hurdles to assess VLE’s financial health.
Does VLE’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. 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. VLE’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. A single-digit revenue growth of 1.9% for VLE is considerably low for a small-cap company. While its low growth hardly justifies opting for zero-debt, the company may have high growth projects in the pipeline to justify the trade-off.
Can VLE pay its short-term liabilities?
Given zero long-term debt on its balance sheet, Valeura Energy has no solvency issues, which is used to describe the company’s ability to meet its long-term obligations. However, another measure of financial health is its short-term obligations, which is known as liquidity. These include payments to suppliers, employees and other stakeholders. Looking at VLE’s most recent CA$4m liabilities, it seems that the business has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 15.42x. However, a ratio greater than 3x may be considered as quite high.
Having no debt on the books means VLE has more financial freedom to keep growing at its current fast rate. This may mean this is an optimal capital structure for the business, given that it is also meeting its short-term commitment. In the future, its financial position may change. I admit this is a fairly basic analysis for VLE’s financial health. Other important fundamentals need to be considered alongside. You should continue to research Valeura Energy to get a more holistic view of the stock by looking at:
- Future Outlook: What are well-informed industry analysts predicting for VLE’s future growth? Take a look at our free research report of analyst consensus for VLE’s outlook.
- Valuation: What is VLE 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 VLE 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 email@example.com.