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The direct benefit for Aura Energy Limited (ASX:AEE), 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 AEE will have to adhere to stricter debt covenants and have less financial flexibility. While AEE 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.
Is AEE growing fast enough to value 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. AEE’s absence of debt on its balance sheet may be due to lack of access to cheaper capital, or it may simply believe low cost is not worth sacrificing financial flexibility. However, choosing flexibility over capital returns is logical only if it’s a high-growth company. AEE’s revenue growth over the past year is a double-digit 39% which is considerably high for a small-cap company. Therefore, the company’s decision to choose financial flexibility is justified as it may need headroom to borrow in the future to sustain high growth.
Can AEE pay its short-term liabilities?
Given zero long-term debt on its balance sheet, Aura Energy 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 AU$332k, it appears that the company has been able to meet these commitments with a current assets level of AU$2.9m, leading to a 8.83x current account ratio. However, many consider a ratio above 3x to be high.
Having no debt on the books means AEE has more financial freedom to keep growing at its current fast rate. Since there is also no concerns around AEE’s liquidity needs, this may be its optimal capital structure for the time being. In the future, AEE’s financial situation may change. I admit this is a fairly basic analysis for AEE’s financial health. Other important fundamentals need to be considered alongside. You should continue to research Aura Energy to get a better picture of the stock by looking at:
- Historical Performance: What has AEE’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.
- Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
To help readers see past 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. For errors that warrant correction please contact the editor at firstname.lastname@example.org.