The direct benefit for Alkane Resources Limited (ASX:ALK), 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 ALK will have to adhere to stricter debt covenants and have less financial flexibility. While ALK has no debt on its balance sheet, it doesn’t necessarily mean it exhibits financial strength. I will go over a basic overview of the stock’s financial health, which I believe provides a ballpark estimate of their financial health status.
Is financial flexibility worth the lower cost of capital?
Debt capital generally has lower cost of capital compared to equity funding. 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. The lack of debt on ALK’s balance sheet may be because it does not have access to cheap capital, or it may believe this trade-off is not worth it. Choosing financial flexibility over capital returns make sense if ALK is a high-growth company. ALK’s revenue growth in the teens of 10% 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.
Can ALK pay its short-term liabilities?
Since Alkane 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. 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. At the current liabilities level of AU$27m, it appears that the company has been able to meet these commitments with a current assets level of AU$93m, leading to a 3.4x current account ratio. However, a ratio above 3x may be considered excessive by some investors, yet this is not usually a major negative for a company.
ALK is a fast-growing firm, which supports having have zero-debt and financial freedom to continue to ramp up growth. This may mean this is an optimal capital structure for the business, given that it is also meeting its short-term commitment. Moving forward, ALK’s financial situation may change. Keep in mind I haven’t considered other factors such as how ALK has been performing in the past. I recommend you continue to research Alkane Resources to get a more holistic view of the stock by looking at:
- Valuation: What is ALK 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 ALK is currently mispriced by the market.
- Historical Performance: What has ALK’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 email@example.com.