The direct benefit for AKM Industrial Company Limited (HKG:1639), 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 1639 will have to adhere to stricter debt covenants and have less financial flexibility. 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.
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Is financial flexibility worth the lower cost of capital?
Debt funding can be cheaper than issuing new equity due to lower interest cost on debt. But the downside of having debt in a company’s balance sheet is the debtholder’s higher claim on its assets in the case of liquidation, as well as stricter capital management requirements. The lack of debt on 1639’s balance sheet may be because it does not have access to cheap capital, or it may believe this trade-off is not worth it. Choosing financial flexibility over capital returns make sense if 1639 is a high-growth company. 1639’s revenue growth in the teens of 12% is not considered as high-growth, especially for a small-cap company. More capital can help the business grow faster. If 1639 is not expecting exceptional future growth, then the decision to avoid may cost shareholders in the long term.
Can 1639 meet its short-term obligations with the cash in hand?
Given zero long-term debt on its balance sheet, AKM Industrial 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 1639’s HK$388m in current liabilities, the company has been able to meet these obligations given the level of current assets of HK$806m, with a current ratio of 2.08x. Generally, for Electronic companies, this is a reasonable ratio as there’s enough of a cash buffer without holding too much capital in low return investments.
1639 is a fast-growing firm, which supports having have zero-debt and financial freedom to continue to ramp up growth. This may mean this is an optimal capital structure for the business, given that it is also meeting its short-term commitment. Moving forward, its financial position may change. I admit this is a fairly basic analysis for 1639’s financial health. Other important fundamentals need to be considered alongside. I suggest you continue to research AKM Industrial to get a more holistic view of the stock by looking at:
- Future Outlook: What are well-informed industry analysts predicting for 1639’s future growth? Take a look at our free research report of analyst consensus for 1639’s outlook.
- Historical Performance: What has 1639’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 firstname.lastname@example.org.