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Zero-debt allows substantial financial flexibility, especially for small-cap companies like Atul Auto Limited (NSE:ATULAUTO), 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 go over a basic overview of the stock’s financial health, which I believe provides a ballpark estimate of their financial health status.
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Does ATULAUTO’s growth rate justify its decision for 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 ATULAUTO 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. ATULAUTO’s revenue growth in the teens of 17% 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 ATULAUTO meet its short-term obligations with the cash in hand?
Given zero long-term debt on its balance sheet, Atul Auto 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 ATULAUTO’s most recent ₹744m liabilities, it seems that the business has been able to meet these obligations given the level of current assets of ₹1.9b, with a current ratio of 2.56x. Usually, for Auto companies, this is a suitable ratio as there’s enough of a cash buffer without holding too much capital in low return investments.
Next Steps:
Having no debt on the books means ATULAUTO has more financial freedom to keep growing at its current fast rate. Since there is also no concerns around ATULAUTO’s liquidity needs, this may be its optimal capital structure for the time being. Moving forward, its financial position may change. This is only a rough assessment of financial health, and I’m sure ATULAUTO has company-specific issues impacting its capital structure decisions. I suggest you continue to research Atul Auto to get a more holistic view of the stock by looking at: