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The direct benefit for Magmatic Resources Limited (ASX:MAG), 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 MAG will have to adhere to stricter debt covenants and have less financial flexibility. While MAG has no debt on its balance sheet, it doesn’t necessarily mean it exhibits financial strength. I will go over a basic overview of the stock’s financial health, which I believe provides a ballpark estimate of their financial health status.
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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 MAG 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. MAG’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.
Can MAG pay its short-term liabilities?
Given zero long-term debt on its balance sheet, Magmatic Resources 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. Looking at MAG’s AU$531k in current liabilities, it appears that the company has been able to meet these commitments with a current assets level of AU$643k, leading to a 1.21x current account ratio. For Metals and Mining companies, this ratio is within a sensible range as there’s enough of a cash buffer without holding too much capital in low return investments.
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As a high-growth company, it may be beneficial for MAG to have some financial flexibility, hence zero-debt. Since there is also no concerns around MAG’s liquidity needs, this may be its optimal capital structure for the time being. Moving forward, its financial position may change. This is only a rough assessment of financial health, and I’m sure MAG has company-specific issues impacting its capital structure decisions. You should continue to research Magmatic Resources to get a better picture of the stock by looking at: