Zero-debt allows substantial financial flexibility, especially for small-cap companies like The Gorman-Rupp Company ( NYSE:GRC ), 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 GRC has no debt on its balance sheet, it doesn’t necessarily mean it exhibits 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. 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. Either GRC 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. A single-digit revenue growth of 7.3% for GRC is considerably low 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.
Can GRC meet its short-term obligations with the cash in hand?
Since Gorman-Rupp 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. With current liabilities at US$54m, it seems that the business has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 4.84x. Having said that, many consider a ratio above 3x to be high, although this is not necessarily a bad thing.
Having no debt on the books means GRC has more financial freedom to keep growing at its current fast rate. Since there is also no concerns around GRC’s liquidity needs, this may be its optimal capital structure for the time being. Moving forward, its financial position may be different. I admit this is a fairly basic analysis for GRC’s financial health. Other important fundamentals need to be considered alongside. I recommend you continue to research Gorman-Rupp to get a better picture of the stock by looking at:
- Future Outlook : What are well-informed industry analysts predicting for GRC’s future growth? Take a look at our free research report of analyst consensus for GRC’s outlook.
- Valuation : What is GRC 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 GRC is currently mispriced by the market.
- 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 email@example.com .