Zero-debt allows substantial financial flexibility, especially for small-cap companies like Neuren Pharmaceuticals Limited (ASX:NEU), 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 NEU has outstanding financial strength. 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 financial flexibility worth the lower cost of capital?
There are well-known benefits of including debt in capital structure, primarily a lower cost of capital. However, the trade-off is debtholders’ higher claim on company assets in the event of liquidation and stringent obligations around capital management. Either NEU 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. NEU delivered a negative revenue growth of -79%. While its negative growth hardly justifies opting for zero-debt, if the decline sustains, it may find it hard to raise debt at an acceptable cost.
Can NEU pay its short-term liabilities?
Given zero long-term debt on its balance sheet, Neuren Pharmaceuticals has no solvency issues, which is 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 NEU’s AU$1.3m in current liabilities, it appears that the company has been able to meet these obligations given the level of current assets of AU$19m, with a current ratio of 14.49x. However, many consider a ratio above 3x to be high, although this is not necessarily a bad thing.
Having no debt on the books means NEU has more financial freedom to keep growing at its current fast rate. Since there is also no concerns around NEU’s liquidity needs, this may be its optimal capital structure for the time being. Moving forward, its financial position may change. Keep in mind I haven’t considered other factors such as how NEU has been performing in the past. You should continue to research Neuren Pharmaceuticals to get a more holistic view of the stock by looking at:
- Future Outlook: What are well-informed industry analysts predicting for NEU’s future growth? Take a look at our free research report of analyst consensus for NEU’s outlook.
- Historical Performance: What has NEU’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.