The direct benefit for Principia Biopharma Inc. (NASDAQ:PRNB), 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 PRNB will have to adhere to stricter debt covenants and have less financial flexibility. Zero-debt can alleviate some risk associated with the company meeting debt obligations, but this doesn’t automatically mean PRNB has outstanding financial strength. I recommend you look at the following hurdles to assess PRNB’s financial health.
Is PRNB right in choosing financial flexibility over lower cost of capital?
There are well-known benefits of including debt in capital structure, primarily a lower cost of capital. 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 PRNB’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 PRNB is a high-growth company. PRNB 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 PRNB’s liquid assets cover its short-term commitments?
Since Principia Biopharma 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$32m, it appears that the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 6.05x. However, a ratio greater than 3x may be considered high by some.
As a high-growth company, it may be beneficial for PRNB 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. In the future, its financial position may change. This is only a rough assessment of financial health, and I’m sure PRNB has company-specific issues impacting its capital structure decisions. You should continue to research Principia Biopharma to get a better picture of the stock by looking at:
- Future Outlook: What are well-informed industry analysts predicting for PRNB’s future growth? Take a look at our free research report of analyst consensus for PRNB’s outlook.
- Historical Performance: What has PRNB’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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