The direct benefit for rhipe Limited (ASX:RHP), 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 RHP 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 RHP 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.
Is RHP 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. 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. The lack of debt on RHP’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 RHP is a high-growth company. A double-digit revenue growth of 25% is considered relatively high for a small-cap company like RHP. 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 RHP’s liquid assets cover its short-term commitments?
Since rhipe 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. Looking at RHP’s AU$47m in current liabilities, it appears that the company has been able to meet these commitments with a current assets level of AU$67m, leading to a 1.44x current account ratio. Usually, for IT companies, this is a suitable ratio since there’s a sufficient cash cushion without leaving too much capital idle or in low-earning investments.
RHP is a fast-growing firm, which supports having have zero-debt and financial freedom to continue to ramp up growth. Since there is also no concerns around RHP’s liquidity needs, this may be its optimal capital structure for the time being. Going forward, its financial position may change. This is only a rough assessment of financial health, and I’m sure RHP has company-specific issues impacting its capital structure decisions. I suggest you continue to research rhipe to get a better picture of the stock by looking at:
- Future Outlook: What are well-informed industry analysts predicting for RHP’s future growth? Take a look at our free research report of analyst consensus for RHP’s outlook.
- Valuation: What is RHP 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 RHP 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.