High Peak Royalties Limited (ASX:HPR), which has zero-debt on its balance sheet, can maximize capital returns by increasing debt due to its lower cost of capital. However, the trade-off is HPR will have to follow strict debt obligations which will reduce its 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 go over a basic overview of the stock’s financial health, which I believe provides a ballpark estimate of their financial health status. See our latest analysis for HPR
Does HPR’s growth rate justify its decision for financial flexibility over lower cost of capital?
Debt capital generally has lower cost of capital compared to equity funding. However, the trade-off is debtholders’ higher claim on company assets in the event of liquidation and stringent obligations around capital management. Either HPR 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. HPR’s revenue growth over the past year is a double-digit 29.41% which is considerably high for a small-cap company. Therefore, the company’s decision to choose financial flexibility is justified as it may need headroom to borrow in the future to sustain high growth.
Can HPR pay its short-term liabilities?
Since High Peak Royalties 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. 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. Looking at HPR’s most recent A$0.0M liabilities, it appears that the company has been able to meet these obligations given the level of current assets of A$1.6M, with a current ratio of 34.16x. Though, anything about 3x may be excessive, since HPR may be leaving too much capital in low-earning investments.
Next Steps:
Are you a shareholder? As a high-growth company, it may be beneficial for HPR to have some financial flexibility, hence zero-debt. Since there is also no concerns around HPR’s liquidity needs, this may be its optimal capital structure for the time being. Going forward, its financial position may be different. I suggest keeping abreast of market expectations for HPR’s future growth.