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Zero-debt allows substantial financial flexibility, especially for small-cap companies like Bauhaus International (Holdings) Limited (HKG:483), 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. Zero-debt can alleviate some risk associated with the company meeting debt obligations, but this doesn’t automatically mean 483 has outstanding financial strength. I will take you through a few basic checks to assess the financial health of companies with no debt.
See our latest analysis for Bauhaus International (Holdings)
Is financial flexibility worth the 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 483’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 483 is a high-growth company. 483’s revenue growth over the past year is a single-digit 6.3% which is relatively low for a small-cap company. 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 483 meet its short-term obligations with the cash in hand?
Given zero long-term debt on its balance sheet, Bauhaus International (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. Looking at 483’s most recent HK$134m liabilities, the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 4.89x. Having said that, many consider anything above 3x to be quite high and could mean that 483 has too much idle capital in low-earning investments.
Next Steps:
Having no debt on the books means 483 has more financial freedom to keep growing at its current fast rate. Since there is also no concerns around 483’s liquidity needs, this may be its optimal capital structure for the time being. Moving forward, its financial position may change. I admit this is a fairly basic analysis for 483’s financial health. Other important fundamentals need to be considered alongside. I suggest you continue to research Bauhaus International (Holdings) to get a better picture of the stock by looking at: