Zero-debt allows substantial financial flexibility, especially for small-cap companies like Fortune Sun (China) Holdings Limited (SEHK:352), 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 352 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. See our latest analysis for Fortune Sun (China) Holdings
Does 352’s growth rate justify its decision for financial flexibility over lower cost of capital?
Debt funding can be cheaper than issuing new equity due to lower interest cost on debt. 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 352 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. 352’s revenue growth over the past year is a double-digit 25.57% which is considerably high for a small-cap company. 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.
Does 352’s liquid assets cover its short-term commitments?
Given zero long-term debt on its balance sheet, Fortune Sun (China) Holdings 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. Looking at 352’s most recent CN¥13.1M liabilities, it seems that the business has been able to meet these obligations given the level of current assets of CN¥74.6M, with a current ratio of 5.7x. However, anything above 3x is considered high and could mean that 352 has too much idle capital in low-earning investments.
Next Steps:
Are you a shareholder? 352 is a fast-growing firm, which supports having have zero-debt and financial freedom to continue to ramp up growth. Since there is also no concerns around 352’s liquidity needs, this may be its optimal capital structure for the time being. Moving forward, 352’s financial situation may change. You should always be keeping abreast of market expectations for 352’s future growth.