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The direct benefit for Great Southern Mining Limited (ASX:GSN), 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 GSN will have to adhere to stricter debt covenants and have less financial flexibility. Zero-debt can alleviate some risk associated with the company meeting debt obligations, but this doesn’t automatically mean GSN has outstanding 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 Great Southern Mining
Does GSN’s growth rate justify its decision for 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. GSN’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, GSN’s negative revenue growth of -95% hardly justifies opting for zero-debt. If the decline sustains, it may find it hard to raise debt at an acceptable cost.
Can GSN pay its short-term liabilities?
Given zero long-term debt on its balance sheet, Great Southern Mining 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. With current liabilities at AU$844k, it seems that the business arguably has a rather low level of current assets relative its obligations, with the current ratio last standing at 0.9x.
Next Steps:
Having no debt on the books means GSN has more financial freedom to keep growing at its current fast rate. However, the company’s low liquidity lowers our conviction around meeting short-term obligations. Some level of low-cost debt funding could help meet these needs. Going forward, its financial position may change. This is only a rough assessment of financial health, and I’m sure GSN has company-specific issues impacting its capital structure decisions. I suggest you continue to research Great Southern Mining to get a more holistic view of the stock by looking at: