Zero-debt allows substantial financial flexibility, especially for small-cap companies like Fenix Resources Limited (ASX:FEX), 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 FEX 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 FEX’s financial health.
Is FEX 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 FEX 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. FEX delivered a negative revenue growth of -51%. While its negative growth hardly justifies opting for zero-debt, if the decline sustains, it may find it hard to raise debt at an acceptable cost.
Can FEX meet its short-term obligations with the cash in hand?
Since Fenix Resources doesn’t have any debt on its balance sheet, it doesn’t have any solvency issues, which is a term 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 AU$106k, it seems that the business has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 4.26x. However, many consider a ratio above 3x to be high.
Having no debt on the books means FEX has more financial freedom to keep growing at its current fast rate. This may mean this is an optimal capital structure for the business, given that it is also meeting its short-term commitment. Going forward, its financial position may change. Keep in mind I haven’t considered other factors such as how FEX has been performing in the past. You should continue to research Fenix Resources to get a more holistic view of the stock by looking at:
- Historical Performance: What has FEX’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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