Zero-debt allows substantial financial flexibility, especially for small-cap companies like Centamin plc (LON:CEY), 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 recommend you look at the following hurdles to assess CEY’s financial health.
See our latest analysis for Centamin
Is financial flexibility worth the lower cost of capital?
There are well-known benefits of including debt in capital structure, primarily a lower cost of capital. 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. CEY’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. CEY delivered a negative revenue growth of -4.9%. 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 CEY’s liquid assets cover its short-term commitments?
Given zero long-term debt on its balance sheet, Centamin 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 CEY’s US$38m in current liabilities, the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 9.85x. However, many consider a ratio above 3x to be high, although this is not necessarily a bad thing.
Next Steps:
CEY 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 CEY’s liquidity needs, this may be its optimal capital structure for the time being. Going forward, its financial position may change. Keep in mind I haven’t considered other factors such as how CEY has been performing in the past. I recommend you continue to research Centamin to get a more holistic view of the stock by looking at:
- Future Outlook: What are well-informed industry analysts predicting for CEY’s future growth? Take a look at our free research report of analyst consensus for CEY’s outlook.
- Valuation: What is CEY 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 CEY is currently mispriced by the market.
- 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 editorial-team@simplywallst.com.