Pacific American Coal Limited (ASX:PAK), which has zero-debt on its balance sheet, can maximize capital returns by increasing debt due to its lower cost of capital. However, the trade-off is PAK will have to follow strict debt obligations which will reduce its financial flexibility. While PAK has no debt on its balance sheet, it doesn’t necessarily mean it exhibits financial strength. I will take you through a few basic checks to assess the financial health of companies with no debt. See our latest analysis for Pacific American Coal
Is PAK 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. Though, the trade-offs are that lenders require stricter capital management requirements, in addition to having a higher claim on company assets relative to shareholders. Either PAK 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 PAK pay its short-term liabilities?
Since Pacific American Coal 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. At the current liabilities level of A$0.3M 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 9.87x current account ratio. Though, a ratio greater than 3x may be considered as too high, as PAK could be holding too much capital in a low-return investment environment.
Next Steps:
Are you a shareholder? PAK is a fast-growing firm, which supports having have zero-debt and financial freedom to continue to ramp up growth. This may mean this is an optimal capital structure for the business, given that it is also meeting its short-term commitment. Moving forward, its financial position may change. I recommend keeping abreast of market expectations for PAK’s future growth.
Are you a potential investor? PAK’s high growth makes financial flexibility an attractive option. Moreover, its high liquidity means the company should continue to operate smoothly in the case of adverse events. To gain more conviction in the stock, you need to also analyse the company’s track record. I encourage you to continue your research by taking a look at PAK’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.