Zero-debt allows substantial financial flexibility, especially for small-cap companies like Focus Minerals Limited (ASX:FML), 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 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 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. However, the trade-off is debtholders’ higher claim on company assets in the event of liquidation and stringent obligations around capital management. Either FML 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. FML delivered a negative revenue growth of -21%. 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.
Does FML’s liquid assets cover its short-term commitments?
Given zero long-term debt on its balance sheet, Focus Minerals 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. With current liabilities at AU$2.3m, the company has been able to meet these commitments with a current assets level of AU$35m, leading to a 14.99x current account ratio. Having said that, many consider anything above 3x to be quite high.
As a high-growth company, it may be beneficial for FML to have some financial flexibility, hence zero-debt. This may mean this is an optimal capital structure for the business, given that it is also meeting its short-term commitment. In the future, its financial position may be different. I admit this is a fairly basic analysis for FML’s financial health. Other important fundamentals need to be considered alongside. You should continue to research Focus Minerals to get a more holistic view of the stock by looking at:
- Historical Performance: What has FML’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.
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