The direct benefit for Telecom Service One Holdings Limited (HKG:3997), 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 3997 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 3997 has outstanding 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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Does 3997’s growth rate justify its decision for financial flexibility over lower cost of capital?
Debt capital generally has lower cost of capital compared to equity funding. 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. Either 3997 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. 3997 delivered a negative revenue growth of -26%. While its negative growth hardly justifies opting for zero-debt, if the decline sustains, it may find it hard to raise debt at an acceptable cost.
Can 3997 pay its short-term liabilities?
Given zero long-term debt on its balance sheet, Telecom Service One Holdings 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. Looking at 3997’s HK$5.4m in current liabilities, it seems that the business has been able to meet these obligations given the level of current assets of HK$102m, with a current ratio of 18.9x. Having said that, a ratio greater than 3x may be considered by some to be quite high, however this is not necessarily a negative for the company.
Next Steps:
3997 is a fast-growing firm, which supports having have zero-debt and financial freedom to continue to ramp up growth. Since there is also no concerns around 3997’s liquidity needs, this may be its optimal capital structure for the time being. Going forward, 3997’s financial situation may change. This is only a rough assessment of financial health, and I’m sure 3997 has company-specific issues impacting its capital structure decisions. I recommend you continue to research Telecom Service One Holdings to get a better picture of the stock by looking at:
- Future Outlook: What are well-informed industry analysts predicting for 3997’s future growth? Take a look at our free research report of analyst consensus for 3997’s outlook.
- Valuation: What is 3997 worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether 3997 is currently mispriced by the market.
- Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.