The direct benefit for R3D Global Limited (ASX:R3D), 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 R3D 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 will go over a basic overview of the stock’s financial health, which I believe provides a ballpark estimate of their financial health status. View our latest analysis for R3D Global
Is R3D right in choosing financial flexibility over lower cost of capital?
Debt capital generally has lower cost of capital compared to equity funding. 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 R3D 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. R3D delivered a negative revenue growth of -25.17%. While its negative growth hardly justifies opting for zero-debt, if the decline sustains, it may find it hard to raise debt at an acceptable cost.
Does R3D’s liquid assets cover its short-term commitments?
Since R3D Global 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. With current liabilities at A$0.1M, it seems that the business has been able to meet these commitments with a current assets level of A$1.1M, leading to a 19.12x current account ratio. However, anything about 3x may be excessive, since R3D may be leaving too much capital in low-earning investments.
Next Steps:
Are you a shareholder? R3D’s soft top-line growth means not taking advantage of lower cost debt may not be the best strategy. Shareholders should understand why the company isn’t opting for cheaper cost of capital to fund future growth, and why financial flexibility is needed at this stage in its business cycle. I suggest you take a look into a future growth analysis to account for what the market expects for the company moving forward.