The direct benefit for GMM Pfaudler Limited (NSE:GMM), 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 GMM 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 GMM has outstanding financial strength. I recommend you look at the following hurdles to assess GMM’s financial health.
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Is financial flexibility worth the 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. GMM’s absence of debt on its balance sheet may be due to lack of access to cheaper capital, or it may simply believe low cost is not worth sacrificing financial flexibility. However, choosing flexibility over capital returns is logical only if it’s a high-growth company. GMM’s revenue growth in the teens of 15% 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.
Does GMM’s liquid assets cover its short-term commitments?
Since GMM Pfaudler 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. Looking at GMM’s ₹1.5b in current liabilities, it seems that the business has been able to meet these obligations given the level of current assets of ₹3.1b, with a current ratio of 2.12x. Generally, for Machinery 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:
GMM 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 GMM’s liquidity needs, this may be its optimal capital structure for the time being. Going forward, its financial position may be different. This is only a rough assessment of financial health, and I’m sure GMM has company-specific issues impacting its capital structure decisions. I recommend you continue to research GMM Pfaudler to get a better picture of the stock by looking at: