The direct benefit for North European Oil Royalty Trust (NYSE:NRT), 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 NRT 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 will go over a basic overview of the stock’s financial health, which I believe provides a ballpark estimate of their financial health status.
Is NRT right in choosing 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. Either NRT 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. NRT’s revenue growth in the teens of 14.9% is not considered as high-growth, especially 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 NRT pay its short-term liabilities?
Given zero long-term debt on its balance sheet, North European Oil Royalty Trust 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 NRT’s most recent US$1.7m liabilities, the company has been able to meet these obligations given the level of current assets of US$1.9m, with a current ratio of 1.08x. Usually, for Oil and Gas companies, this is a suitable ratio since there is a bit of a cash buffer without leaving too much capital in a low-return environment.
NRT is a fast-growing firm, which supports having have zero-debt and financial freedom to continue to ramp up growth. 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 NRT’s financial health. Other important fundamentals need to be considered alongside. You should continue to research North European Oil Royalty Trust to get a more holistic view of the stock by looking at:
- Valuation: What is NRT 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 NRT is currently mispriced by the market.
- Historical Performance: What has NRT’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.