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First Au Limited (ASX:FAU), 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 FAU will have to follow strict debt obligations which will reduce its financial flexibility. While FAU 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.
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Does FAU’s growth rate justify its decision for financial flexibility over lower cost of capital?
Debt capital generally has lower cost of capital compared to equity funding. 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. Either FAU 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. Opposite to the high growth we were expecting, FAU’s negative revenue growth of -99% hardly justifies opting for zero-debt. If the decline sustains, it may find it hard to raise debt at an acceptable cost.
Can FAU meet its short-term obligations with the cash in hand?
Since First Au doesn’t have any debt on its balance sheet, it doesn’t have any solvency issues, which is a term 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$379k, the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 14.13x. Having said that, many consider anything above 3x to be quite high and could mean that FAU has too much idle capital in low-earning investments.
Next Steps:
Having no debt on the books means FAU has more financial freedom to keep growing at its current fast rate. This may mean this is an optimal capital structure for the business, given that it is also meeting its short-term commitment. Going forward, FAU’s financial situation may change. Keep in mind I haven’t considered other factors such as how FAU has been performing in the past. You should continue to research First Au to get a better picture of the stock by looking at:
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Historical Performance: What has FAU’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.