PetroNeft Resources plc (ISE:P8ET), 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 P8ET will have to follow strict debt obligations which will reduce its financial flexibility. Zero-debt can alleviate some risk associated with the company meeting debt obligations, but this doesn’t automatically mean P8ET has outstanding financial strength. I will take you through a few basic checks to assess the financial health of companies with no debt. Check out our latest analysis for PetroNeft Resources
Does P8ET’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. 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. P8ET’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, P8ET’s negative revenue growth of -24.87% hardly justifies opting for zero-debt. If the decline sustains, it may find it hard to raise debt at an acceptable cost.
Can P8ET meet its short-term obligations with the cash in hand?
Given zero long-term debt on its balance sheet, PetroNeft Resources 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. At the current liabilities level of US$1.72m liabilities, it seems that the business is not able to meet these obligations given the level of current assets of US$618.90k, with a current ratio of 0.36x below the prudent level of 3x.
As a high-growth company, it may be beneficial for P8ET to have some financial flexibility, hence zero-debt. Though, the company’s low liquidity lowers our conviction around meeting near-term commitments. Some level of low-cost debt funding could help address these needs. ] %} Moving forward, P8ET’s financial situation may change. This is only a rough assessment of financial health, and I’m sure P8ET has company-specific issues impacting its capital structure decisions. I suggest you continue to research PetroNeft Resources to get a more holistic view of the stock by looking at:
- Valuation: What is P8ET 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 P8ET is currently mispriced by the market.
- Historical Performance: What has P8ET’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.