Zero-debt allows substantial financial flexibility, especially for small-cap companies like Antilles Oil and Gas NL (ASX:AVD), 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 AVD has outstanding financial strength. I will take you through a few basic checks to assess the financial health of companies with no debt. See our latest analysis for Antilles Oil and Gas
Does AVD’s growth rate justify its decision for financial flexibility over lower cost of capital?
Debt funding can be cheaper than issuing new equity due to lower interest cost on debt. 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. AVD’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, AVD’s negative revenue growth of -29.08% hardly justifies opting for zero-debt. If the decline sustains, it may find it hard to raise debt at an acceptable cost.
Does AVD’s liquid assets cover its short-term commitments?
Given zero long-term debt on its balance sheet, Antilles Oil and Gas 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. At the current liabilities level of A$0.2M liabilities, the company has been able to meet these obligations given the level of current assets of A$3.1M, with a current ratio of 19.65x. Though, anything about 3x may be excessive, since AVD may be leaving too much capital in low-earning investments.
Next Steps:
Are you a shareholder? Given that Antilles Oil and Gas is a relatively low-growth company, being in a zero-debt position isn’t always optimal. Shareholders should understand why the company isn’t opting for cheaper cost of capital to fund future growth, and why financial flexibility is needed at this stage in its business cycle. I suggest you take a look into a future growth analysis to properly assess the company’s position.