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Zero-debt allows substantial financial flexibility, especially for small-cap companies like Australian Bauxite Limited (ASX:ABX), as the company does not have to adhere to strict debt covenants. However, it also faces higher cost of capital given interest cost is generally lower than equity. While ABX 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.
Check out our latest analysis for Australian Bauxite
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. But the downside of having debt in a company’s balance sheet is the debtholder’s higher claim on its assets in the case of liquidation, as well as stricter capital management requirements. Either ABX 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. ABX delivered a negative revenue growth of -271%. While its negative growth hardly justifies opting for zero-debt, if the decline sustains, it may find it hard to raise debt at an acceptable cost.
Can ABX pay its short-term liabilities?
Given zero long-term debt on its balance sheet, Australian Bauxite 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. With current liabilities at AU$2.0m, the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 1.15x. Usually, for Metals and Mining companies, this is a suitable ratio as there’s enough of a cash buffer without holding too much capital in low return investments.
Next Steps:
As a high-growth company, it may be beneficial for ABX to have some financial flexibility, hence zero-debt. 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 be different. Keep in mind I haven’t considered other factors such as how ABX has been performing in the past. I suggest you continue to research Australian Bauxite to get a more holistic view of the stock by looking at:
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Valuation: What is ABX worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether ABX is currently mispriced by the market.
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Historical Performance: What has ABX’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.
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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 editorial-team@simplywallst.com.