Zero-debt allows substantial financial flexibility, especially for small-cap companies like AeroVironment Inc (NASDAQ:AVAV), 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. View our latest analysis for AeroVironment

Does AVAV’s growth rate justify its decision for financial flexibility over lower cost of capital?

There are well-known benefits of including debt in capital structure, primarily a lower cost of capital. 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 AVAV’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 AVAV is a high-growth company. A single-digit revenue growth of 0.29% for AVAV is considerably low for a small-cap company. More capital can help the business grow faster. If AVAV is not expecting exceptional future growth, then the decision to avoid may cost shareholders in the long term.

Does AVAV’s liquid assets cover its short-term commitments?

At the current liabilities level of US$48.06M liabilities, it appears that the company has been able to meet these obligations given the level of current assets of US$354.09M, with a current ratio of 7.37x. However, a ratio greater than 3x may be considered as too high, as AVAV could be holding too much capital in a low-return investment environment.

Next Steps:

AVAV 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 AVAV’s liquidity needs, this may be its optimal capital structure for the time being. Moving forward, its financial position may be different. This is only a rough assessment of financial health, and I’m sure AVAV has company-specific issues impacting its capital structure decisions. I suggest you continue to research AeroVironment to get a better picture of the stock by looking at:

• 1. Future Outlook: What are well-informed industry analysts predicting for AVAV’s future growth? Take a look at our free research report of analyst consensus for AVAV’s outlook.

• 2. Valuation: What is AVAV 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 AVAV is currently mispriced by the market.

• 3. 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 pass 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.