Zero-debt allows substantial financial flexibility, especially for small-cap companies like Pura Vida Energy NL (ASX:PVD), 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.

View our latest analysis for Pura Vida Energy

Is financial flexibility worth the 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. The lack of debt on PVD’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 PVD is a high-growth company. Opposite to the high growth we were expecting, PVD’s negative revenue growth of -49% hardly justifies opting for zero-debt. If the decline sustains, it may find it hard to raise debt at an acceptable cost.

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

Since Pura Vida Energy 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. At the current liabilities level of AU$4m liabilities, it appears that the company has been able to meet these obligations given the level of current assets of AU$9m, with a current ratio of 2.16x. Generally, for Oil and Gas companies, this is a reasonable ratio since there’s a sufficient cash cushion without leaving too much capital idle or in low-earning investments.

Next Steps:

Having no debt on the books means PVD has more financial freedom to keep growing at its current fast rate. Since there is also no concerns around PVD’s liquidity needs, this may be its optimal capital structure for the time being. In the future, its financial position may be different. This is only a rough assessment of financial health, and I’m sure PVD has company-specific issues impacting its capital structure decisions. I recommend you continue to research Pura Vida Energy to get a better picture of the stock by looking at: