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IBI Group Holdings Limited (HKG:1547), 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 1547 will have to follow strict debt obligations which will reduce its financial flexibility. While 1547 has no debt on its balance sheet, it doesn’t necessarily mean it exhibits financial strength. I recommend you look at the following hurdles to assess 1547’s financial health.
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Is 1547 right in choosing financial flexibility over 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. Either 1547 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. Opposite to the high growth we were expecting, 1547’s negative revenue growth of -5.6% hardly justifies opting for zero-debt. If the decline sustains, it may find it hard to raise debt at an acceptable cost.
Can 1547 meet its short-term obligations with the cash in hand?
Given zero long-term debt on its balance sheet, IBI Group Holdings 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. With current liabilities at HK$155m, the company has been able to meet these commitments with a current assets level of HK$294m, leading to a 1.9x current account ratio. Generally, for Construction companies, this is a reasonable ratio since there’s a sufficient cash cushion without leaving too much capital idle or in low-earning investments.
Next Steps:
Having no debt on the books means 1547 has more financial freedom to keep growing at its current fast rate. Since there is also no concerns around 1547’s liquidity needs, this may be its optimal capital structure for the time being. Going forward, 1547’s financial situation may change. This is only a rough assessment of financial health, and I’m sure 1547 has company-specific issues impacting its capital structure decisions. You should continue to research IBI Group Holdings to get a more holistic view of the stock by looking at: