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The direct benefit for PropNex Limited (SGX:OYY), 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 OYY will have to adhere to stricter debt covenants and have less financial flexibility. Zero-debt can alleviate some risk associated with the company meeting debt obligations, but this doesn’t automatically mean OYY has outstanding financial strength. I recommend you look at the following hurdles to assess OYY’s financial health.
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Is OYY 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. However, the trade-off is debtholders’ higher claim on company assets in the event of liquidation and stringent obligations around capital management. Either OYY 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. OYY’s revenue growth over the past year is a double-digit 32% which is considerably high for a small-cap company. 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.
Can OYY meet its short-term obligations with the cash in hand?
Given zero long-term debt on its balance sheet, PropNex 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. At the current liabilities level of S$89m, the company has been able to meet these commitments with a current assets level of S$156m, leading to a 1.75x current account ratio. For Real Estate companies, this ratio is within a sensible range as there’s enough of a cash buffer without holding too much capital in low return investments.
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As a high-growth company, it may be beneficial for OYY to have some financial flexibility, hence zero-debt. Since there is also no concerns around OYY’s liquidity needs, this may be its optimal capital structure for the time being. In the future, its financial position may change. This is only a rough assessment of financial health, and I’m sure OYY has company-specific issues impacting its capital structure decisions. You should continue to research PropNex to get a more holistic view of the stock by looking at: