Vision Values Holdings Limited (SEHK:862), 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 862 will have to follow strict debt obligations which will reduce its 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 recommend you look at the following hurdles to assess 862’s financial health. See our latest analysis for Vision Values 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. 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. 862’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, 862’s negative revenue growth of -15.71% hardly justifies opting for zero-debt. If the decline sustains, it may find it hard to raise debt at an acceptable cost.
Can 862 pay its short-term liabilities?
Since Vision Values 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. But another important aspect of financial health is liquidity: the company’s ability to meet short-term obligations, including payments to suppliers and employees. Looking at 862’s most recent HK$13.3M liabilities, it appears that the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 20.89x. Though, a ratio greater than 3x may be considered as too high, as 862 could be holding too much capital in a low-return investment environment.
Next Steps:
Are you a shareholder? 862’s soft top-line growth means not having any low-cost debt funding may not be optimal for the business. As shareholders, you should try and determine whether this strategy is justified for 862, and whether the company needs financial flexibility at this point in time. You should take a look into a future growth analysis to examine what the market expects for the company moving forward.