The direct benefit for Chesser Resources Limited (ASX:CHZ), 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 CHZ will have to adhere to stricter debt covenants and have less financial flexibility. While zero-debt makes the due diligence for potential investors less nerve-racking, it poses a new question: how should they assess the financial strength of such companies? I will take you through a few basic checks to assess the financial health of companies with no debt. View our latest analysis for Chesser Resources
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. The lack of debt on CHZ’s balance sheet may be because it does not have access to cheap capital, or it may believe this trade-off is not worth it. Choosing financial flexibility over capital returns make sense if CHZ is a high-growth company. Opposite to the high growth we were expecting, CHZ’s negative revenue growth of -96.77% hardly justifies opting for zero-debt. If the decline sustains, it may find it hard to raise debt at an acceptable cost.
Can CHZ meet its short-term obligations with the cash in hand?
Given zero long-term debt on its balance sheet, Chesser Resources 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 A$0.1M liabilities, it appears that the company has been able to meet these obligations given the level of current assets of A$3.3M, with a current ratio of 24.35x. However, a ratio greater than 3x may be considered as too high, as CHZ could be holding too much capital in a low-return investment environment.
Next Steps:
Are you a shareholder? CHZ’s soft top-line growth means not having any low-cost debt funding may not be optimal for the business. 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. You should take a look into a future growth analysis to properly assess what the market expects for the company moving forward.