Café de Coral Holdings Limited (SEHK:341), which has zero-debt on its balance sheet, can maximize capital returns by increasing debt due to its lower cost of capital. However, the trade-off is 341 will have to follow strict debt obligations which will reduce its financial flexibility. Zero-debt can alleviate some risk associated with the company meeting debt obligations, but this doesn’t automatically mean 341 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. View our latest analysis for Café de Coral Holdings
Does 341’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. 341’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. 341’s revenue growth over the past year is a single-digit 4.34% which is relatively low for a small-cap company. More capital can help the business grow faster. If 341 is not expecting exceptional future growth, then the decision to avoid may cost shareholders in the long term.
Can 341 meet its short-term obligations with the cash in hand?
Since Café de Coral 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$845.9M liabilities, the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 1.51x. Generally, for hospitality companies, this is a reasonable ratio as there’s enough of a cash buffer without holding too capital in low return investments.
Next Steps:
Are you a shareholder? 341’s soft top-line growth means not taking advantage of lower cost debt may not be the best strategy. Shareholders should understand why the company isn’t opting for cheaper cost of capital to fund future growth, and why financial flexibility is needed at this stage in its business cycle. You should take a look into a future growth analysis to examine the company’s position.