Zero-debt allows substantial financial flexibility, especially for small-cap companies like TEM Holdings Limited (SEHK:8346), 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. 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 recommend you look at the following hurdles to assess 8346’s financial health. See our latest analysis for TEM Holdings
Is 8346 right in choosing financial flexibility over lower cost of capital?
Debt capital generally has lower cost of capital compared to equity funding. 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 8346’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 8346 is a high-growth company. 8346 delivered a negative revenue growth of -11.15%. 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 8346 meet its short-term obligations with the cash in hand?
Given zero long-term debt on its balance sheet, TEM 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. At the current liabilities level of HK$12.1M liabilities, it seems that the business has been able to meet these commitments with a current assets level of HK$140.2M, leading to a 11.54x current account ratio. Though, anything above 3x is considered high and could mean that 8346 has too much idle capital in low-earning investments.
Next Steps:
Are you a shareholder? 8346’s soft top-line growth means not taking advantage of lower cost debt may not be the best strategy. As shareholders, you should try and determine whether this strategy is justified for 8346, and whether the company needs financial flexibility at this point in time. You should take a look into a future growth analysis to properly assess what the market expects for the company moving forward.
Are you a potential investor? In terms of meeting is short term obligations, there’s nothing to worry about for 8346. But, a relatively low revenue growth could hurt returns, meaning there is some benefit to looking at low-cost funding alternatives. This is only a rough assessment of financial health, and I’m sure 8346 has company-specific issues impacting its capital structure decisions. You should continue your analysis by taking a look at 8346’s past performance to figure out 8346’s financial health position.
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.