Zero-debt allows substantial financial flexibility, especially for small-cap companies like E Lighting Group Holdings Limited (SEHK:8222), 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 recommend you look at the following hurdles to assess 8222’s financial health. Check out our latest analysis for E Lighting Group Holdings
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. 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. 8222’s absence of debt on its balance sheet may be due to lack of access to cheaper capital, or it may simply believe low cost is not worth sacrificing financial flexibility. However, choosing flexibility over capital returns is logical only if it’s a high-growth company. Opposite to the high growth we were expecting, 8222’s negative revenue growth of -21.83% hardly justifies opting for zero-debt. If the decline sustains, it may find it hard to raise debt at an acceptable cost.
Does 8222’s liquid assets cover its short-term commitments?
Since E Lighting Group Holdings 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. 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. At the current liabilities level of HK$10.35M liabilities, the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 3.63x. However, anything above 3x is considered high and could mean that 8222 has too much idle capital in low-earning investments.
8222’s soft top-line growth means having no debt on its balance sheet isn’t necessarily the best thing. As shareholders, you should try and determine whether this strategy is justified for 8222, and why financial flexibility is needed at this stage in its business cycle. This is only a rough assessment of financial health, and I’m sure 8222 has company-specific issues impacting its capital structure decisions. You should continue to research E Lighting Group Holdings to get a better picture of the stock by looking at:
- 1. Historical Performance: What has 8222’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.
- 2. 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.