Zero-debt allows substantial financial flexibility, especially for small-cap companies like Azucar Minerals Ltd. (CVE:AMZ), 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.
Is AMZ right in choosing financial flexibility over lower cost of capital?
Debt funding can be cheaper than issuing new equity due to lower interest cost on debt. 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. Either AMZ does not have access to cheap capital, or it may believe this trade-off is not worth it. This makes sense only if the company has a competitive edge and is growing fast off its equity capital. AMZ delivered a strikingly high revenue growth of 57% over the past year. So, it is acceptable that the company is opting for a zero-debt capital structure currently as it may need to raise debt to fuel expansion in the future.
Does AMZ’s liquid assets cover its short-term commitments?
Given zero long-term debt on its balance sheet, Azucar Minerals 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. With current liabilities at CA$621k, it seems that the business has been able to meet these obligations given the level of current assets of CA$16m, with a current ratio of 26.44x. Having said that, a ratio above 3x may be considered excessive by some investors, yet this is not usually a major negative for a company.
As a high-growth company, it may be beneficial for AMZ to have some financial flexibility, hence zero-debt. This may mean this is an optimal capital structure for the business, given that it is also meeting its short-term commitment. Moving forward, its financial position may change. I admit this is a fairly basic analysis for AMZ’s financial health. Other important fundamentals need to be considered alongside. I recommend you continue to research Azucar Minerals to get a better picture of the stock by looking at:
- Historical Performance: What has AMZ’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.