Zero-debt allows substantial financial flexibility, especially for small-cap companies like China Best Group Holding Limited (HKG:370), 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 take you through a few basic checks to assess the financial health of companies with no debt.
Is 370 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. 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 370 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. Opposite to the high growth we were expecting, 370’s negative revenue growth of -16% hardly justifies opting for zero-debt. If the decline sustains, it may find it hard to raise debt at an acceptable cost.
Can 370 meet its short-term obligations with the cash in hand?
Since China Best Group Holding 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. With current liabilities at HK$54m, it seems that the business has been able to meet these commitments with a current assets level of HK$1.1b, leading to a 20.12x current account ratio. Having said that, a ratio greater than 3x may be considered high by some.
As a high-growth company, it may be beneficial for 370 to have some financial flexibility, hence zero-debt. This may mean this is an optimal capital structure for the business, given that it is also meeting its short-term commitment. Going forward, its financial position may change. This is only a rough assessment of financial health, and I’m sure 370 has company-specific issues impacting its capital structure decisions. You should continue to research China Best Group Holding to get a more holistic view of the stock by looking at:
- Future Outlook: What are well-informed industry analysts predicting for 370’s future growth? Take a look at our free research report of analyst consensus for 370’s outlook.
- Historical Performance: What has 370’s returns been like over the past? Go into more detail in the past track record analysis and take a look at the free visual representations of our analysis for more clarity.
- 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 email@example.com.