TAG Oil Ltd. (TSE:TAO), 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 TAO 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 will go over a basic overview of the stock’s financial health, which I believe provides a ballpark estimate of their financial health status.
Does TAO’s growth rate justify its decision for financial flexibility over lower cost of capital?
Debt capital generally has lower cost of capital compared to equity funding. Though, the trade-offs are that lenders require stricter capital management requirements, in addition to having a higher claim on company assets relative to shareholders. TAO’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. TAO’s revenue growth over the past year is a double-digit 25% which is considerably high for a small-cap company. Therefore, the company’s decision to choose financial flexibility is justified as it may need headroom to borrow in the future to sustain high growth.
Can TAO meet its short-term obligations with the cash in hand?
Since TAG Oil 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. With current liabilities at CA$5.6m, it appears that the company has been able to meet these commitments with a current assets level of CA$7.9m, leading to a 1.42x current account ratio. Generally, for Oil and Gas companies, this is a reasonable ratio since there is a bit of a cash buffer without leaving too much capital in a low-return environment.
TAO is a fast-growing firm, which supports having have zero-debt and financial freedom to continue to ramp up growth. Since there is also no concerns around TAO’s liquidity needs, this may be its optimal capital structure for the time being. Going forward, its financial position may be different. This is only a rough assessment of financial health, and I’m sure TAO has company-specific issues impacting its capital structure decisions. You should continue to research TAG Oil to get a more holistic view of the stock by looking at:
- Historical Performance: What has TAO’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.
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