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The direct benefit for BOE Varitronix Limited (HKG:710), 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 710 will have to adhere to stricter debt covenants and have less financial flexibility. While 710 has no debt on its balance sheet, it doesn’t necessarily mean it exhibits financial strength. 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?
Debt funding can be cheaper than issuing new equity due to lower interest cost on debt. However, the trade-off is debtholders’ higher claim on company assets in the event of liquidation and stringent obligations around capital management. Either 710 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 double-digit revenue growth of 30% is considered relatively high for a small-cap company like 710. So, it is acceptable that the company is opting for a zero-debt capital structure currently as it may need to raise debt to fuel expansion in the future.
Does 710’s liquid assets cover its short-term commitments?
Since BOE Varitronix 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. At the current liabilities level of HK$556m, it seems that the business has been able to meet these obligations given the level of current assets of HK$2.8b, with a current ratio of 4.98x. Having said that, a ratio above 3x may be considered excessive by some investors, yet this is not usually a major negative for a company.
Next Steps:
710 is a fast-growing firm, which supports having have zero-debt and financial freedom to continue to ramp up growth. This may mean this is an optimal capital structure for the business, given that it is also meeting its short-term commitment. Going forward, its financial position may be different. I admit this is a fairly basic analysis for 710’s financial health. Other important fundamentals need to be considered alongside. You should continue to research BOE Varitronix to get a better picture of the stock by looking at: