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Zero-debt allows substantial financial flexibility, especially for small-cap companies like Kinergy Corporation Ltd (HKG:3302), 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. 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 3302’s financial health.
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Is 3302 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. 3302’s absence of debt on its balance sheet may be due to lack of access to cheaper capital, or it may simply believe low cost is not worth sacrificing financial flexibility. However, choosing flexibility over capital returns is logical only if it’s a high-growth company. A double-digit revenue growth of 26% is considered relatively high for a small-cap company like 3302. Therefore, the company’s decision to choose financial flexibility is justified as it may need headroom to borrow in the future to sustain high growth.
Does 3302’s liquid assets cover its short-term commitments?
Given zero long-term debt on its balance sheet, Kinergy has no solvency issues, which is 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 S$49m liabilities, it seems that the business has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 2.07x. For Electronic companies, this ratio is within a sensible range since there is a bit of a cash buffer without leaving too much capital in a low-return environment.
Next Steps:
Having no debt on the books means 3302 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. Moving forward, 3302’s financial situation may change. This is only a rough assessment of financial health, and I’m sure 3302 has company-specific issues impacting its capital structure decisions. I suggest you continue to research Kinergy to get a better picture of the stock by looking at: