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Zero-debt allows substantial financial flexibility, especially for small-cap companies like MRG Metals Ltd (ASX:MRQ), 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 take you through a few basic checks to assess the financial health of companies with no debt.
Does MRQ’s growth rate justify its decision for financial flexibility over 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. MRQ’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, MRQ’s negative revenue growth of -68% hardly justifies opting for zero-debt. If the decline sustains, it may find it hard to raise debt at an acceptable cost.
Can MRQ pay its short-term liabilities?
Given zero long-term debt on its balance sheet, MRG Metals has no solvency issues, which is 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 MRQ’s AU$84k in current liabilities, it appears that the company has been able to meet these commitments with a current assets level of AU$1.8m, leading to a 20.9x current account ratio. Having said that, a ratio above 3x may be considered excessive by some investors.
Having no debt on the books means MRQ has more financial freedom to keep growing at its current fast rate. Since there is also no concerns around MRQ’s liquidity needs, this may be its optimal capital structure for the time being. In the future, its financial position may change. Keep in mind I haven’t considered other factors such as how MRQ has been performing in the past. You should continue to research MRG Metals to get a better picture of the stock by looking at:
- Historical Performance: What has MRQ’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.