Viking Mines Limited (ASX:VKA), 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 VKA will have to follow strict debt obligations which will reduce its financial flexibility. Zero-debt can alleviate some risk associated with the company meeting debt obligations, but this doesn’t automatically mean VKA has outstanding financial strength. I will take you through a few basic checks to assess the financial health of companies with no debt. View our latest analysis for Viking Mines
Is financial flexibility worth the 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 VKA 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 VKA’s liquid assets cover its short-term commitments?
Given zero long-term debt on its balance sheet, Viking Mines 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$0.3M liabilities, it seems that the business has been able to meet these commitments with a current assets level of A$2.1M, leading to a 6.23x current account ratio. Though, anything above 3x is considered high and could mean that VKA has too much idle capital in low-earning investments.
Next Steps:
Are you a shareholder? Having no debt on the books means VKA has more financial freedom to keep growing at its current fast rate. Since there is also no concerns around VKA’s liquidity needs, this may be its optimal capital structure for the time being. In the future, its financial position may change. I recommend keeping on top of market expectations for VKA’s future growth.
Are you a potential investor? VKA’s high growth makes financial flexibility an attractive option. In addition, 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 examine VKA’s track record. You should continue your analysis by taking a look at VKA’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.