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The direct benefit for Oilex Ltd (ASX:OEX), which sports a zero-debt capital structure, to include debt in its capital structure is the reduced cost of capital. However, the trade-off is OEX will have to adhere to stricter debt covenants and have less financial flexibility. While OEX has no debt on its balance sheet, it doesn’t necessarily mean it exhibits financial strength. 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 OEX’s growth rate justify its decision for financial flexibility over 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. OEX’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. OEX’s revenue growth over the past year is an impressively high double-digit 78%. 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.
Does OEX’s liquid assets cover its short-term commitments?
Given zero long-term debt on its balance sheet, Oilex 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. At the current liabilities level of AU$1.9m, the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 1.36x. Usually, for Oil and Gas companies, this is a suitable ratio as there’s enough of a cash buffer without holding too much capital in low return investments.
As a high-growth company, it may be beneficial for OEX to have some financial flexibility, hence zero-debt. Since there is also no concerns around OEX’s liquidity needs, this may be its optimal capital structure for the time being. Moving forward, its financial position may be different. This is only a rough assessment of financial health, and I’m sure OEX has company-specific issues impacting its capital structure decisions. You should continue to research Oilex to get a better picture of the stock by looking at:
- Historical Performance: What has OEX’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.