Zero-debt allows substantial financial flexibility, especially for small-cap companies like Equatorial Resources Limited (ASX:EQX), 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. While EQX 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. See our latest analysis for EQX
Does EQX’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. 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. EQX’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. EQX delivered a negative revenue growth of -4.31%. 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 EQX’s liquid assets cover its short-term commitments?
Since Equatorial 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. With current liabilities at A$0.2M liabilities, it appears that the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 189.44x. Though, anything above 3x is considered high and could mean that EQX has too much idle capital in low-earning investments.
Next Steps:
Are you a shareholder? Since EQX is a low-growth stock in terms of its revenues, not taking advantage of lower cost debt may not be the best strategy. As shareholders, you should try and determine whether this strategy is justified for EQX, 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.
Are you a potential investor? EQX’s health in terms of financial liquidity should ease potential investors’ concerns. But, its soft revenue growth means there’s potential to improve return on capital by taking on some debt and ramp up growth. I admit this is a fairly basic analysis for EQX’s financial health. Other important fundamentals need to be considered alongside. For your next step, you should take a look at EQX’s past performance to figure out EQX’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.