The direct benefit for Radius Gold Inc (CVE:RDU), 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 RDU will have to adhere to stricter debt covenants and have less financial flexibility. While RDU 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 RDU’s financial health.
Is financial flexibility worth the 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. RDU’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.
Can RDU meet its short-term obligations with the cash in hand?
Given zero long-term debt on its balance sheet, Radius Gold 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 CA$189.0k liabilities, it seems that the business has been able to meet these commitments with a current assets level of CA$10.3m, leading to a 54.59x current account ratio. Though, a ratio greater than 3x may be considered as too high, as RDU could be holding too much capital in a low-return investment environment.
As a high-growth company, it may be beneficial for RDU to have some financial flexibility, hence zero-debt. Since there is also no concerns around RDU’s liquidity needs, this may be its optimal capital structure for the time being. In the future, its financial position may be different. Keep in mind I haven’t considered other factors such as how RDU has been performing in the past. I recommend you continue to research Radius Gold to get a more holistic view of the stock by looking at:
- Historical Performance: What has RDU’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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