Pearl Global Limited (ASX:PG1), which has zero-debt on its balance sheet, can maximize capital returns by increasing debt due to its lower cost of capital. However, the trade-off is PG1 will have to follow strict debt obligations which will reduce its 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 take you through a few basic checks to assess the financial health of companies with no debt.
Check out our latest analysis for Pearl Global
Does PG1’s growth rate justify its decision for 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. PG1’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. PG1 delivered a negative revenue growth of -70%. 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.
Can PG1 pay its short-term liabilities?
Given zero long-term debt on its balance sheet, Pearl Global has no solvency issues, which is 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$349k, it appears that the company has been able to meet these obligations given the level of current assets of AU$3.8m, with a current ratio of 10.87x. However, a ratio above 3x may be considered excessive by some investors.
Next Steps:
As a high-growth company, it may be beneficial for PG1 to have some financial flexibility, hence zero-debt. Since there is also no concerns around PG1’s liquidity needs, this may be its optimal capital structure for the time being. Moving forward, PG1’s financial situation may change. I admit this is a fairly basic analysis for PG1’s financial health. Other important fundamentals need to be considered alongside. I recommend you continue to research Pearl Global to get a more holistic view of the stock by looking at: