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Zero-debt allows substantial financial flexibility, especially for small-cap companies like Traka Resources Limited (ASX:TKL), as the company does not have to adhere to strict debt covenants. However, it also faces higher cost of capital given interest cost is generally lower than equity. While zero-debt makes the due diligence for potential investors less nerve-racking, it poses a new question: how should they assess the financial strength of such companies? 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.
See our latest analysis for Traka Resources
Is TKL right in choosing financial flexibility over 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 TKL 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. TKL’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 TKL meet its short-term obligations with the cash in hand?
Given zero long-term debt on its balance sheet, Traka 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 TKL’s most recent AU$94.7k liabilities, the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 16.29x. Though, a ratio greater than 3x may be considered as too high, as TKL could be holding too much capital in a low-return investment environment.
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Having no debt on the books means TKL has more financial freedom to keep growing at its current fast rate. Since there is also no concerns around TKL’s liquidity needs, this may be its optimal capital structure for the time being. In the future, its financial position may change. This is only a rough assessment of financial health, and I’m sure TKL has company-specific issues impacting its capital structure decisions. I suggest you continue to research Traka Resources to get a better picture of the stock by looking at: