Want to participate in a short research study? Help shape the future of investing tools and you could win a $250 gift card!
The direct benefit for Frontier Resources Limited (ASX:FNT), 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 FNT will have to adhere to stricter debt covenants and have less financial flexibility. While FNT has no debt on its balance sheet, it doesn’t necessarily mean it exhibits financial strength. I will take you through a few basic checks to assess the financial health of companies with no debt.
Is FNT 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. However, the trade-off is debtholders’ higher claim on company assets in the event of liquidation and stringent obligations around capital management. Either FNT 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, FNT’s negative revenue growth of -71% hardly justifies opting for zero-debt. If the decline sustains, it may find it hard to raise debt at an acceptable cost.
Can FNT meet its short-term obligations with the cash in hand?
Given zero long-term debt on its balance sheet, Frontier Resources 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 FNT’s AU$358k in current liabilities, it appears that the company has been able to meet these obligations given the level of current assets of AU$6.0m, with a current ratio of 16.72x. However, a ratio above 3x may be considered excessive by some investors.
FNT 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 FNT’s liquidity needs, this may be its optimal capital structure for the time being. In the future, FNT’s financial situation may change. This is only a rough assessment of financial health, and I’m sure FNT has company-specific issues impacting its capital structure decisions. I suggest you continue to research Frontier Resources to get a better picture of the stock by looking at:
- Historical Performance: What has FNT’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 firstname.lastname@example.org.