Zero-debt allows substantial financial flexibility, especially for small-cap companies like Dragon Group International Limited (SGX:MT1), 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. Zero-debt can alleviate some risk associated with the company meeting debt obligations, but this doesn’t automatically mean MT1 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 MT1
Is MT1 growing fast enough to value 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. The lack of debt on MT1’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 MT1 is a high-growth company. MT1’s revenue growth over the past year is an impressively high double-digit 52.89%. So, it is acceptable that the company is opting for a zero-debt capital structure currently as it may need to raise debt to fuel expansion in the future.
Can MT1 meet its short-term obligations with the cash in hand?
Given zero long-term debt on its balance sheet, Dragon Group International 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. At the current liabilities level of $2.7M 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 1.56x. Usually, for electronic companies, this is a suitable ratio as there’s enough of a cash buffer without holding too capital in low return investments.
Next Steps:
Are you a shareholder? MT1’s soft top-line growth means 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, especially if meeting short-term obligations could also bring about issues. You should take a look into a future growth analysis to account for what the market expects for the company moving forward.