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Human Health Holdings Limited (HKG:1419), 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 1419 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 will take you through a few basic checks to assess the financial health of companies with no debt.
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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. However, the trade-off is debtholders’ higher claim on company assets in the event of liquidation and stringent obligations around capital management. 1419’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. 1419’s revenue growth over the past year is a single-digit 7.7% which is relatively low for a small-cap company. More capital can help the business grow faster. If 1419 is not expecting exceptional future growth, then the decision to avoid may cost shareholders in the long term.
Does 1419’s liquid assets cover its short-term commitments?
Since Human Health 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$63m, it seems that the business has been able to meet these obligations given the level of current assets of HK$242m, with a current ratio of 3.87x. However, a ratio greater than 3x may be considered by some to be quite high, however this is not necessarily a negative for the company.
Next Steps:
As a high-growth company, it may be beneficial for 1419 to have some financial flexibility, hence zero-debt. Since there is also no concerns around 1419’s liquidity needs, this may be its optimal capital structure for the time being. Moving forward, its financial position may be different. I admit this is a fairly basic analysis for 1419’s financial health. Other important fundamentals need to be considered alongside. I recommend you continue to research Human Health Holdings to get a better picture of the stock by looking at: