China Wan Tong Yuan (Holdings) Limited (HKG:8199), 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 8199 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 recommend you look at the following hurdles to assess 8199’s financial health.
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Does 8199’s growth rate justify its decision for 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. The lack of debt on 8199’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 8199 is a high-growth company. 8199 delivered a negative revenue growth of -4.8%. 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 8199 pay its short-term liabilities?
Given zero long-term debt on its balance sheet, China Wan Tong Yuan (Holdings) has no solvency issues, which is 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 CN¥32m, the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 3.22x. Having said that, a ratio greater than 3x may be considered as quite high, and some might argue 8199 could be holding too much capital in a low-return investment environment.
Next Steps:
As a high-growth company, it may be beneficial for 8199 to have some financial flexibility, hence zero-debt. Since there is also no concerns around 8199’s liquidity needs, this may be its optimal capital structure for the time being. In the future, its financial position may be different. Keep in mind I haven’t considered other factors such as how 8199 has been performing in the past. I suggest you continue to research China Wan Tong Yuan (Holdings) to get a better picture of the stock by looking at: