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New Age Exploration Limited (ASX:NAE), 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 NAE 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 NAE has outstanding financial strength. I recommend you look at the following hurdles to assess NAE’s financial health.
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Is NAE growing fast enough to value financial flexibility over lower cost of capital?
Debt capital generally has lower cost of capital compared to equity funding. However, the trade-off is debtholders’ higher claim on company assets in the event of liquidation and stringent obligations around capital management. NAE’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. Opposite to the high growth we were expecting, NAE’s negative revenue growth of -57% hardly justifies opting for zero-debt. If the decline sustains, it may find it hard to raise debt at an acceptable cost.
Can NAE meet its short-term obligations with the cash in hand?
Given zero long-term debt on its balance sheet, New Age Exploration 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. At the current liabilities level of AU$150k liabilities, it appears that the company has been able to meet these commitments with a current assets level of AU$1m, leading to a 7.56x current account ratio. Having said that, a ratio greater than 3x may be considered as quite high, and some might argue NAE could be holding too much capital in a low-return investment environment.
Next Steps:
NAE is a fast-growing firm, which supports having have zero-debt and financial freedom to continue to ramp up growth. Since there is also no concerns around NAE’s liquidity needs, this may be its optimal capital structure for the time being. In the future, NAE’s financial situation may change. I admit this is a fairly basic analysis for NAE’s financial health. Other important fundamentals need to be considered alongside. I suggest you continue to research New Age Exploration to get a more holistic view of the stock by looking at: