Renascor Resources Limited (ASX:RNU), 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 RNU 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 recommend you look at the following hurdles to assess RNU’s financial health.
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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. 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 RNU 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. RNU’s revenue growth over the past year is a single-digit 0.1% which is relatively low for a small-cap company. More capital can help the business grow faster. If RNU is not expecting exceptional future growth, then the decision to avoid may cost shareholders in the long term.
Can RNU pay its short-term liabilities?
Since Renascor Resources 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. With current liabilities at AU$826k, it seems that the business has been able to meet these obligations given the level of current assets of AU$8.5m, with a current ratio of 10.27x. However, many consider a ratio above 3x to be high.
Next Steps:
As a high-growth company, it may be beneficial for RNU to have some financial flexibility, hence zero-debt. Since there is also no concerns around RNU’s liquidity needs, this may be its optimal capital structure for the time being. Going forward, its financial position may change. This is only a rough assessment of financial health, and I’m sure RNU has company-specific issues impacting its capital structure decisions. I suggest you continue to research Renascor Resources to get a better picture of the stock by looking at:
- Future Outlook: What are well-informed industry analysts predicting for RNU’s future growth? Take a look at our free research report of analyst consensus for RNU’s outlook.
- Historical Performance: What has RNU’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 editorial-team@simplywallst.com.