Cardinal Resources Limited (ASX:CDV), 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 CDV 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 CDV has outstanding financial strength. I recommend you look at the following hurdles to assess CDV’s financial health.
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Is CDV right in choosing financial flexibility over lower cost of capital?
There are well-known benefits of including debt in capital structure, primarily a lower cost of capital. 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. The lack of debt on CDV’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 CDV is a high-growth company. A revenue growth in the teens is not considered high-growth. CDV’s revenue growth of 17% falls into this range. While its low growth hardly justifies opting for zero-debt, the company may have high growth projects in the pipeline to justify the trade-off.
Does CDV’s liquid assets cover its short-term commitments?
Given zero long-term debt on its balance sheet, Cardinal Resources 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$5m liabilities, it seems that the business has been able to meet these commitments with a current assets level of AU$10m, leading to a 2.03x current account ratio. Generally, for Metals and Mining companies, this is a reasonable ratio since there’s a sufficient cash cushion without leaving too much capital idle or in low-earning investments.
Next Steps:
CDV 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 CDV’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 CDV has been performing in the past. You should continue to research Cardinal Resources to get a more holistic view of the stock by looking at: