In This Article:
Key Petroleum Limited (ASX:KEY), 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 KEY 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 KEY 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 Key Petroleum
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. However, the trade-off is debtholders’ higher claim on company assets in the event of liquidation and stringent obligations around capital management. Either KEY 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. KEY’s revenue growth over the past year was an impressively high triple-digit rate, therefore the company’s decision to choose financial flexibility is justified as it may need headroom to borrow in the future to sustain high growth.
Does KEY’s liquid assets cover its short-term commitments?
Given zero long-term debt on its balance sheet, Key Petroleum 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$363k, it seems that the business has been able to meet these commitments with a current assets level of AU$1m, leading to a 3.9x current account ratio. Having said that, a ratio greater than 3x may be considered as quite high, and some might argue KEY could be holding too much capital in a low-return investment environment.
Next Steps:
KEY is a fast-growing firm, which supports having have zero-debt and financial freedom to continue to ramp up growth. 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 change. I admit this is a fairly basic analysis for KEY’s financial health. Other important fundamentals need to be considered alongside. I recommend you continue to research Key Petroleum to get a more holistic view of the stock by looking at: