Is Legacy Iron Ore Limited’s (ASX:LCY) Balance Sheet Strong Enough To Weather A Storm?
Zero-debt allows substantial financial flexibility, especially for small-cap companies like Legacy Iron Ore Limited (ASX:LCY), 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. Zero-debt can alleviate some risk associated with the company meeting debt obligations, but this doesn’t automatically mean LCY has outstanding financial strength. I will take you through a few basic checks to assess the financial health of companies with no debt.
Check out our latest analysis for Legacy Iron Ore
Is LCY right in choosing financial flexibility over lower cost of capital?
Debt capital generally has lower cost of capital compared to equity funding. 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. LCY’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. Opposite to the high growth we were expecting, LCY’s negative revenue growth of -16% hardly justifies opting for zero-debt. If the decline sustains, it may find it hard to raise debt at an acceptable cost.
Can LCY meet its short-term obligations with the cash in hand?
Given zero long-term debt on its balance sheet, Legacy Iron Ore 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$141k liabilities, it appears that the company has been able to meet these obligations given the level of current assets of AU$4m, with a current ratio of 28.79x. Having said that, a ratio greater than 3x may be considered as quite high.
Next Steps:
Having no debt on the books means LCY has more financial freedom to keep growing at its current fast rate. Since there is also no concerns around LCY’s liquidity needs, this may be its optimal capital structure for the time being. In the future, LCY’s financial situation may change. I admit this is a fairly basic analysis for LCY’s financial health. Other important fundamentals need to be considered alongside. I recommend you continue to research Legacy Iron Ore to get a better picture of the stock by looking at:
Historical Performance: What has LCY’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 editorial-team@simplywallst.com.
