The direct benefit for Pavillon Holdings Ltd (SGX:596), 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 596 will have to adhere to stricter debt covenants and have less financial flexibility. Zero-debt can alleviate some risk associated with the company meeting debt obligations, but this doesn’t automatically mean 596 has outstanding financial strength. I recommend you look at the following hurdles to assess 596’s financial health. Check out our latest analysis for Pavillon Holdings
Is 596 right in choosing financial flexibility over 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. Either 596 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. A revenue growth in the teens is not considered high-growth. 596’s revenue growth of 18.58% falls into this range. While its low growth hardly justifies opting for zero-debt, the company may have high growth projects in the pipeline to justify the trade-off.
Can 596 meet its short-term obligations with the cash in hand?
Since Pavillon 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. With current liabilities at SGD5.4M liabilities, the company has been able to meet these commitments with a current assets level of SGD33.9M, leading to a 6.31x current account ratio. However, a ratio greater than 3x may be considered as too high, as 596 could be holding too much capital in a low-return investment environment.
Next Steps:
Are you a shareholder? As a high-growth company, it may be beneficial for 596 to have some financial flexibility, hence zero-debt. Since there is also no concerns around 596’s liquidity needs, this may be its optimal capital structure for the time being. In the future, its financial position may change. You should always be keeping on top of market expectations for 596’s future growth.
Are you a potential investor? 596’s high growth makes financial flexibility an attractive option. In addition, its high liquidity ensures the company will continue to operate smoothly should unfavourable circumstances arise. To gain more confidence in the stock, you need to also examine 596’s track record. I encourage you to continue your research by taking a look at 596’s past performance in order to determine for yourself whether its zero-debt position is justified.
To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned.