Zero-debt allows substantial financial flexibility, especially for small-cap companies like Fraser Range Metals Group Limited (ASX:FRN), 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 take you through a few basic checks to assess the financial health of companies with no debt. View our latest analysis for Fraser Range Metals Group
Does FRN’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. Either FRN 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.
Can FRN pay its short-term liabilities?
Since Fraser Range Metals Group 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 FRN’s most recent A$0.0M liabilities, it seems that the business has been able to meet these commitments with a current assets level of A$2.9M, leading to a 262.13x current account ratio. However, a ratio greater than 3x may be considered as too high, as FRN could be holding too much capital in a low-return investment environment.
Next Steps:
Having no debt on the books means FRN has more financial freedom to keep growing at its current fast rate. Since there is also no concerns around FRN’s liquidity needs, this may be its optimal capital structure for the time being. Moving forward, FRN’s financial situation may change. Keep in mind I haven’t considered other factors such as how FRN has been performing in the past. I recommend you continue to research Fraser Range Metals Group to get a better picture of the stock by looking at:
1. Historical Performance: What has FRN’s returns been like over the past? Go into more detail in the past track record analysis and take a look at the free visual representations of our analysis for more clarity.