The direct benefit for Rocky Brands Inc (NASDAQ:RCKY), 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 RCKY 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 RCKY’s financial health.
Is RCKY growing fast enough to value financial flexibility over lower cost of capital?
Debt funding can be cheaper than issuing new equity due to lower interest cost on debt. 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 RCKY’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 RCKY is a high-growth company. Opposite to the high growth we were expecting, RCKY’s negative revenue growth of -4.0% hardly justifies opting for zero-debt. If the decline sustains, it may find it hard to raise debt at an acceptable cost.
Can RCKY meet its short-term obligations with the cash in hand?
Given zero long-term debt on its balance sheet, Rocky Brands 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 RCKY’s most recent US$33.6m liabilities, it seems that the business has been able to meet these obligations given the level of current assets of US$134.8m, with a current ratio of 4.02x. Having said that, a ratio greater than 3x may be considered as quite high, and some might argue RCKY could be holding too much capital in a low-return investment environment.
As a high-growth company, it may be beneficial for RCKY to have some financial flexibility, hence zero-debt. Since there is also no concerns around RCKY’s liquidity needs, this may be its optimal capital structure for the time being. In the future, its financial position may be different. Keep in mind I haven’t considered other factors such as how RCKY has been performing in the past. I suggest you continue to research Rocky Brands to get a better picture of the stock by looking at:
- Future Outlook: What are well-informed industry analysts predicting for RCKY’s future growth? Take a look at our free research report of analyst consensus for RCKY’s outlook.
- Valuation: What is RCKY 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 RCKY 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 firstname.lastname@example.org.