The direct benefit for Traka Resources Limited (ASX:TKL), 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 TKL 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 recommend you look at the following hurdles to assess TKL’s financial health. View our latest analysis for Traka Resources
Is TKL 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. However, the trade-off is debtholders’ higher claim on company assets in the event of liquidation and stringent obligations around capital management. Either TKL 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. TKL delivered a negative revenue growth of -27.12%. 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 TKL’s liquid assets cover its short-term commitments?
Given zero long-term debt on its balance sheet, Traka Resources 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. At the current liabilities level of A$0.0M liabilities, the company has been able to meet these commitments with a current assets level of A$0.9M, leading to a 20.71x current account ratio. However, anything above 3x is considered high and could mean that TKL has too much idle capital in low-earning investments.
Next Steps:
Are you a shareholder? TKL’s soft top-line growth means not having any low-cost debt funding may not be optimal for the business. Shareholders should understand why the company isn’t opting for cheaper cost of capital to fund future growth, and whether the company needs financial flexibility at this point in time. I recommend taking a look into a future growth analysis to properly assess the company’s position.
Are you a potential investor? TKL’s health in terms of financial liquidity should ease potential investors’ concerns. Though, its low sales growth means there’s potential to improve return on capital by taking on some debt and ramp up growth. This is only a rough assessment of financial health, and I’m sure TKL has company-specific issues impacting its capital structure decisions. I encourage you to continue your research by taking a look at TKL’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.