The direct benefit for Great Southern Mining Limited (ASX:GSN), 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 GSN will have to adhere to stricter debt covenants and have less financial flexibility. While GSN 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?
Debt funding can be cheaper than issuing new equity due to lower interest cost on debt. However, the trade-off is debtholders’ higher claim on company assets in the event of liquidation and stringent obligations around capital management. GSN’s absence of debt on its balance sheet may be due to lack of access to cheaper capital, or it may simply believe low cost is not worth sacrificing financial flexibility. However, choosing flexibility over capital returns is logical only if it’s a high-growth company. Opposite to the high growth we were expecting, GSN’s negative revenue growth of -95% hardly justifies opting for zero-debt. If the decline sustains, it may find it hard to raise debt at an acceptable cost.
Does GSN’s liquid assets cover its short-term commitments?
Since Great Southern Mining 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. Looking at GSN’s AU$844k in current liabilities, it appears that the company arguably has a rather low level of current assets relative its obligations, with the current ratio last standing at 0.9x.
GSN’s soft top-line growth means being in a zero-debt position isn’t always optimal. As shareholders, you should try and determine whether this strategy is justified for GSN, especially when liquidity may also be an issue. Keep in mind I haven’t considered other factors such as how GSN has been performing in the past. You should continue to research Great Southern Mining to get a more holistic view of the stock by looking at:
- Historical Performance: What has GSN’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.