Why Emergent Resources Limited (ASX:EMG) Has Zero-Debt On Its Balance Sheet
The direct benefit for Emergent Resources Limited (ASX:EMG), 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 EMG will have to adhere to stricter debt covenants and have less financial flexibility. While EMG 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. View our latest analysis for Emergent Resources
Is EMG growing fast enough to value 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 EMG 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. EMG delivered a negative revenue growth of -34.13%. 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.
Does EMG’s liquid assets cover its short-term commitments?
Since Emergent 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. 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 EMG’s most recent A$0.0M liabilities, the company has been able to meet these commitments with a current assets level of A$1.3M, leading to a 35.51x current account ratio. Though, a ratio greater than 3x may be considered as too high, as EMG could be holding too much capital in a low-return investment environment.
Next Steps:
Are you a shareholder? EMG’s soft top-line growth means not taking advantage of lower cost debt may not be the best strategy. Shareholders should understand why the company isn’t opting for cheaper cost of capital to fund future growth, and whether the company needs financial flexibility at this point in time. I suggest you take a look into a future growth analysis to properly assess what the market expects for the company moving forward.
Are you a potential investor? In terms of meeting is short term obligations, there’s nothing to worry about for EMG. Though, a relatively low revenue growth could hurt returns, meaning there is some benefit to looking at low-cost funding alternatives. Keep in mind I haven’t considered other factors such as how EMG has been performing in the past. You should continue your analysis by taking a look at EMG’s past performance to figure out EMG’s financial health position.
To help readers see pass 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.
