The direct benefit for Santa Fe Minerals Ltd (ASX:EZA), 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 EZA will have to adhere to stricter debt covenants and have less 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 take you through a few basic checks to assess the financial health of companies with no debt. View our latest analysis for Santa Fe Minerals
Is EZA right in choosing financial flexibility over lower cost of capital?
Debt funding can be cheaper than issuing new equity due to lower interest cost on debt. But the downside of having debt in a company’s balance sheet is the debtholder’s higher claim on its assets in the case of liquidation, as well as stricter capital management requirements. The lack of debt on EZA’s balance sheet may be because it does not have access to cheap capital, or it may believe this trade-off is not worth it. Choosing financial flexibility over capital returns make sense if EZA is a high-growth company.
Can EZA meet its short-term obligations with the cash in hand?
Since Santa Fe 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. But another important aspect of financial health is liquidity: the company’s ability to meet short-term obligations, including payments to suppliers and employees. Looking at EZA’s most recent A$0.1M liabilities, the company has been able to meet these obligations given the level of current assets of A$8.8M, with a current ratio of 108.5x. Though, a ratio greater than 3x may be considered as too high, as EZA could be holding too much capital in a low-return investment environment.
Next Steps:
Are you a shareholder? Having no debt on the books means EZA has more financial freedom to keep growing at its current fast rate. This may mean this is an optimal capital structure for the business, given that it is also meeting its short-term commitment. Moving forward, EZA’s financial situation may change. You should always be keeping abreast of market expectations for EZA’s future growth.
Are you a potential investor? Santa Fe Minerals is a fast-growing company, making financial flexibility a valuable option for the company. In addition, 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 also examine EZA’s track record. You should continue your analysis by taking a look at EZA’s past performance to figure out EZA’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.