Zero-debt allows substantial financial flexibility, especially for small-cap companies like Pacifico Minerals Limited (ASX:PMY), 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 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 Pacifico Minerals
Does PMY’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. However, the trade-off is debtholders’ higher claim on company assets in the event of liquidation and stringent obligations around capital management. PMY’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. PMY delivered a negative revenue growth of -81.68%. 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 PMY’s liquid assets cover its short-term commitments?
Given zero long-term debt on its balance sheet, Pacifico Minerals 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. Looking at PMY’s most recent A$0.2M liabilities, it seems that the business has been able to meet these commitments with a current assets level of A$1.6M, leading to a 9.69x current account ratio. Though, anything above 3x is considered high and could mean that PMY has too much idle capital in low-earning investments.
Next Steps:
Are you a shareholder? As PMY’s revenues are not growing at a fast enough pace, 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 why financial flexibility is needed at this stage in its business cycle. I recommend taking a look into a future growth analysis to examine the company’s position.