Zero-debt allows substantial financial flexibility, especially for small-cap companies like POZ Minerals Limited (ASX:POZ), 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 recommend you look at the following hurdles to assess POZ’s financial health. View our latest analysis for POZ Minerals
Is POZ right in choosing financial flexibility over lower cost of capital?
There are well-known benefits of including debt in capital structure, primarily a lower cost of capital. However, the trade-off is debtholders’ higher claim on company assets in the event of liquidation and stringent obligations around capital management. Either POZ 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.
Does POZ’s liquid assets cover its short-term commitments?
Since POZ Minerals 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 POZ’s most recent A$0.1M liabilities, it seems that the business has been able to meet these obligations given the level of current assets of A$2.0M, with a current ratio of 18.81x. However, anything about 3x may be excessive, since POZ may be leaving too much capital in low-earning investments.
Next Steps:
Are you a shareholder? Having no debt on the books means POZ has more financial freedom to keep growing at its current fast rate. Since there is also no concerns around POZ’s liquidity needs, this may be its optimal capital structure for the time being. Going forward, its financial position may change. I recommend keeping abreast of market expectations for POZ’s future growth.
Are you a potential investor? POZ Minerals is a fast-growing company, making financial flexibility a valuable option for the company. Moreover, its high liquidity means the company should continue to operate smoothly in the case of adverse events. To gain more confidence in the stock, you need to further examine the company’s track record. You should continue your analysis by taking a look at POZ’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.