The direct benefit for Asian American Medical Group Limited (ASX:AJJ), 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 AJJ 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 AJJ has outstanding financial strength. I will take you through a few basic checks to assess the financial health of companies with no debt. See our latest analysis for AJJ
Does AJJ’s growth rate justify its decision for financial flexibility over lower cost of capital?
There are well-known benefits of including debt in capital structure, primarily a lower cost of capital. 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. Either AJJ 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. AJJ delivered a negative revenue growth of -11.22%. 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 AJJ pay its short-term liabilities?
Given zero long-term debt on its balance sheet, Asian American Medical Group 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. At the current liabilities level of SGD5.9M liabilities, it appears that the company has been able to meet these commitments with a current assets level of SGD15.5M, leading to a 2.61x current account ratio. Generally, for healthcare companies, this is a reasonable ratio since there is a bit of a cash buffer without leaving too much capital in a low-return environment.
Next Steps:
Are you a shareholder? Since AJJ is a low-growth stock in terms of its revenues, not having any low-cost debt funding may not be optimal for the business. As an investor, you may want to figure out if there are company-specific reasons for not having any debt, and why financial flexibility is needed at this stage in its business cycle. I suggest you take a look into a future growth analysis to examine the company’s position.