The direct benefit for Sol-Gel Technologies Ltd (NASDAQ:SLGL), 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 SLGL 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 SLGL has outstanding financial strength. I will take you through a few basic checks to assess the financial health of companies with no debt.
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. However, the trade-off is debtholders’ higher claim on company assets in the event of liquidation and stringent obligations around capital management. Either SLGL 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.
Can SLGL meet its short-term obligations with the cash in hand?
Given zero long-term debt on its balance sheet, Sol-Gel Technologies has no solvency issues, which is 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 SLGL’s most recent US$3.9m liabilities, it appears that the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 20.77x. Though, anything above 3x is considered high and could mean that SLGL has too much idle capital in low-earning investments.
Having no debt on the books means SLGL has more financial freedom to keep growing at its current fast rate. Since there is also no concerns around SLGL’s liquidity needs, this may be its optimal capital structure for the time being. In the future, its financial position may change. Keep in mind I haven’t considered other factors such as how SLGL has been performing in the past. You should continue to research Sol-Gel Technologies to get a more holistic view of the stock by looking at:
- Future Outlook: What are well-informed industry analysts predicting for SLGL’s future growth? Take a look at our free research report of analyst consensus for SLGL’s outlook.
- Historical Performance: What has SLGL’s returns been like over the past? Go into more detail in the past track record analysis and take a look at the free visual representations of our analysis for more clarity.
- 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 past 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. For errors that warrant correction please contact the editor at firstname.lastname@example.org.