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Golden Resources Development International Limited (HKG:677), 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 677 will have to follow strict debt obligations which will reduce its financial flexibility. While 677 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 677 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. 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 677’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 677 is a high-growth company. 677’s revenue growth in the teens of 13% is not considered as high-growth, especially 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 677 meet its short-term obligations with the cash in hand?
Since Golden Resources Development International 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 HK$124m, it appears that the company has been able to meet these commitments with a current assets level of HK$828m, leading to a 6.67x current account ratio. Having said that, many consider anything above 3x to be quite high and could mean that 677 has too much idle capital in low-earning investments.
Next Steps:
Having no debt on the books means 677 has more financial freedom to keep growing at its current fast rate. This may mean this is an optimal capital structure for the business, given that it is also meeting its short-term commitment. In the future, 677’s financial situation may change. Keep in mind I haven’t considered other factors such as how 677 has been performing in the past. You should continue to research Golden Resources Development International to get a better picture of the stock by looking at: