The direct benefit for Metgasco Limited (ASX:MEL), 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 MEL 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 MEL’s financial health.
Is financial flexibility worth the 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. The lack of debt on MEL’s balance sheet may be because it does not have access to cheap capital, or it may believe this trade-off is not worth it. Choosing financial flexibility over capital returns make sense if MEL is a high-growth company. A double-digit revenue growth of 22% is considered relatively high for a small-cap company like MEL. 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.
Does MEL’s liquid assets cover its short-term commitments?
Given zero long-term debt on its balance sheet, Metgasco has no solvency issues, which is 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 MEL’s AU$292k in current liabilities, it appears that the company has been able to meet these commitments with a current assets level of AU$13m, leading to a 44.49x current account ratio. Having said that, a ratio greater than 3x may be considered by some to be quite high, however this is not necessarily a negative for the company.
Having no debt on the books means MEL has more financial freedom to keep growing at its current fast rate. Since there is also no concerns around MEL’s liquidity needs, this may be its optimal capital structure for the time being. Moving forward, its financial position may change. Keep in mind I haven’t considered other factors such as how MEL has been performing in the past. I suggest you continue to research Metgasco to get a better picture of the stock by looking at:
- Future Outlook: What are well-informed industry analysts predicting for MEL’s future growth? Take a look at our free research report of analyst consensus for MEL’s outlook.
- Historical Performance: What has MEL’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 email@example.com.