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The direct benefit for Alice Queen Limited (ASX:AQX), 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 AQX will have to adhere to stricter debt covenants and have less financial flexibility. While AQX has no debt on its balance sheet, it doesn’t necessarily mean it exhibits financial strength. I will go over a basic overview of the stock’s financial health, which I believe provides a ballpark estimate of their financial health status.
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Is AQX 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. Though, the trade-offs are that lenders require stricter capital management requirements, in addition to having a higher claim on company assets relative to shareholders. Either AQX 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. AQX delivered a negative revenue growth of -11%. 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 AQX’s liquid assets cover its short-term commitments?
Given zero long-term debt on its balance sheet, Alice Queen has no solvency issues, which is 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$1.4m, it seems that the business may not have an easy time meeting these commitments with a current assets level of AU$680k, leading to a current ratio of 0.5x.
Next Steps:
AQX is a fast-growing firm, which supports having have zero-debt and financial freedom to continue to ramp up growth. However, its lack of liquidity reduces our confidence around meeting near-term commitments. Some level of low-cost debt funding could help meet these needs. Going forward, its financial position may be different. This is only a rough assessment of financial health, and I’m sure AQX has company-specific issues impacting its capital structure decisions. I suggest you continue to research Alice Queen to get a more holistic view of the stock by looking at: