Zero-debt allows substantial financial flexibility, especially for small-cap companies like Route1 Inc (CVE:ROI), 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 will take you through a few basic checks to assess the financial health of companies with no debt.
Is ROI 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. ROI’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. ROI’s revenue growth over the past year is a double-digit 39% which is considerably high for a small-cap company. 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.
Can ROI meet its short-term obligations with the cash in hand?
Since Route1 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. 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 ROI’s most recent CA$5m liabilities, the company has been able to meet these commitments with a current assets level of CA$5m, leading to a 1.03x current account ratio. For Software companies, this ratio is within a sensible range since there’s a sufficient cash cushion without leaving too much capital idle or in low-earning investments.
Having no debt on the books means ROI 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, ROI’s financial situation may change. This is only a rough assessment of financial health, and I’m sure ROI has company-specific issues impacting its capital structure decisions. I recommend you continue to research Route1 to get a better picture of the stock by looking at:
- Future Outlook: What are well-informed industry analysts predicting for ROI’s future growth? Take a look at our free research report of analyst consensus for ROI’s outlook.
- Historical Performance: What has ROI’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 firstname.lastname@example.org.