Zero-debt allows substantial financial flexibility, especially for small-cap companies like Focus Minerals Limited (ASX:FML), 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 FML has no debt on its balance sheet, it doesn’t necessarily mean it exhibits financial strength. I recommend you look at the following hurdles to assess FML’s financial health.
Does FML’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. Either FML 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. Opposite to the high growth we were expecting, FML’s negative revenue growth of -21% hardly justifies opting for zero-debt. If the decline sustains, it may find it hard to raise debt at an acceptable cost.
Can FML pay its short-term liabilities?
Given zero long-term debt on its balance sheet, Focus Minerals has no solvency issues, which is used to describe the company’s ability to meet its long-term obligations. But another important aspect of financial health is liquidity: the company’s ability to meet short-term obligations, including payments to suppliers and employees. Looking at FML’s most recent AU$2m liabilities, it seems that the business has been able to meet these commitments with a current assets level of AU$35m, leading to a 14.99x current account ratio. However, a ratio greater than 3x may be considered as quite high, and some might argue FML could be holding too much capital in a low-return investment environment.
FML 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 FML’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 FML has company-specific issues impacting its capital structure decisions. I suggest you continue to research Focus Minerals to get a more holistic view of the stock by looking at:
- Historical Performance: What has FML’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.
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