The direct benefit for Focus Minerals Limited (ASX:FML), 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 FML will have to adhere to stricter debt covenants and have less financial flexibility. Zero-debt can alleviate some risk associated with the company meeting debt obligations, but this doesn’t automatically mean FML has outstanding 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. View our latest analysis for Focus Minerals
Is FML 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 FML 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. FML delivered a negative revenue growth of -47.66%. 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.
Can FML pay its short-term liabilities?
Given zero long-term debt on its balance sheet, Focus Minerals 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$2.4M liabilities, the company has been able to meet these obligations given the level of current assets of A$49.9M, with a current ratio of 21.08x. However, a ratio greater than 3x may be considered as too high, as FML could be holding too much capital in a low-return investment environment.
Next Steps:
Are you a shareholder? Given that Focus Minerals is a relatively low-growth company, not taking advantage of lower cost debt may not be the best strategy. As an investor, you may want to figure out if there are company-specific reasons for not having any debt, and whether the company needs financial flexibility at this point in time. You should take a look into a future growth analysis to account for the company’s position.
Are you a potential investor? The company’s current holding of liquid assets gives it some level of security in any case of adverse events. But, 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 FML has been performing in the past. I encourage you to continue your research by taking a look at FML’s past performance in order to determine for yourself whether its zero-debt position is justified.
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.