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The direct benefit for Huaxi Holdings Company Limited (HKG:1689), which sports a zero-debt capital structure, to include debt in its capital structure is the reduced cost of capital. However, the trade-off is 1689 will have to adhere to stricter debt covenants and have less financial flexibility. While 1689 has no debt on its balance sheet, it doesn’t necessarily mean it exhibits financial strength. I will take you through a few basic checks to assess the financial health of companies with no debt.
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Is 1689 right in choosing 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. 1689’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. 1689 delivered a negative revenue growth of -20%. While its negative growth hardly justifies opting for zero-debt, if the decline sustains, it may find it hard to raise debt at an acceptable cost.
Can 1689 meet its short-term obligations with the cash in hand?
Since Huaxi 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. With current liabilities at HK$106m, the company has been able to meet these obligations given the level of current assets of HK$396m, with a current ratio of 3.73x. However, anything above 3x may be considered excessive by some investors. They might argue 1689 is leaving too much capital in low-earning investments.
Next Steps:
Having no debt on the books means 1689 has more financial freedom to keep growing at its current fast rate. Since there is also no concerns around 1689’s liquidity needs, this may be its optimal capital structure for the time being. Going forward, its financial position may be different. I admit this is a fairly basic analysis for 1689’s financial health. Other important fundamentals need to be considered alongside. I recommend you continue to research Huaxi Holdings to get a more holistic view of the stock by looking at: