Zero-debt allows substantial financial flexibility, especially for small-cap companies like China Hanya Group Holdings Limited (SEHK:8312), 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. See our latest analysis for China Hanya Group Holdings
Does 8312’s growth rate justify its decision for financial flexibility over lower cost of capital?
Debt capital generally has lower cost of capital compared to equity funding. However, the trade-off is debtholders’ higher claim on company assets in the event of liquidation and stringent obligations around capital management. The lack of debt on 8312’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 8312 is a high-growth company. Opposite to the high growth we were expecting, 8312’s negative revenue growth of -57.46% hardly justifies opting for zero-debt. If the decline sustains, it may find it hard to raise debt at an acceptable cost.
Can 8312 meet its short-term obligations with the cash in hand?
Since China Hanya 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$2.1M liabilities, it appears that the company has been able to meet these obligations given the level of current assets of HK$39.1M, with a current ratio of 18.45x. However, anything above 3x is considered high and could mean that 8312 has too much idle capital in low-earning investments.
Next Steps:
Are you a shareholder? Given that China Hanya Group Holdings is a relatively low-growth company, having no debt on its balance sheet isn’t necessarily the best thing. Shareholders should understand why the company isn’t opting for cheaper cost of capital to fund future growth, and whether the company needs financial flexibility at this point in time. I recommend taking a look into a future growth analysis to examine the company’s position.