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The direct benefit for Collerina Cobalt Limited (ASX:CLL), 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 CLL 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 CLL has outstanding financial strength. I recommend you look at the following hurdles to assess CLL’s financial health.
See our latest analysis for Collerina Cobalt
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. CLL’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, CLL’s negative revenue growth of -84% hardly justifies opting for zero-debt. If the decline sustains, it may find it hard to raise debt at an acceptable cost.
Does CLL’s liquid assets cover its short-term commitments?
Since Collerina Cobalt 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. Looking at CLL’s AU$842k in current liabilities, it seems that the business has been able to meet these commitments with a current assets level of AU$1.2m, leading to a 1.38x current account ratio. Generally, for Metals and Mining companies, this is a reasonable ratio since there is a bit of a cash buffer without leaving too much capital in a low-return environment.
Next Steps:
Since CLL is a low-growth stock in terms of its revenues, having no debt on its balance sheet isn’t necessarily the best thing. As shareholders, you should try and determine whether this strategy is justified for CLL, and whether the company needs financial flexibility at this point in time. I admit this is a fairly basic analysis for CLL’s financial health. Other important fundamentals need to be considered alongside. I suggest you continue to research Collerina Cobalt to get a better picture of the stock by looking at: