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The direct benefit for Nexion Technologies Limited (HKG:8420), 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 8420 will have to adhere to stricter debt covenants and have less financial flexibility. While 8420 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 8420’s financial health.
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Is 8420 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 8420 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. 8420’s revenue growth over the past year was an impressively high triple-digit rate, 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 8420 pay its short-term liabilities?
Given zero long-term debt on its balance sheet, Nexion Technologies 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 US$2m liabilities, it seems that the business has been able to meet these commitments with a current assets level of US$13m, leading to a 6.3x current account ratio. Having said that, a ratio greater than 3x may be considered as quite high, and some might argue 8420 could be holding too much capital in a low-return investment environment.
Next Steps:
8420 is a fast-growing firm, which supports having have zero-debt and financial freedom to continue to ramp up growth. Since there is also no concerns around 8420’s liquidity needs, this may be its optimal capital structure for the time being. Moving forward, its financial position may be different. Keep in mind I haven’t considered other factors such as how 8420 has been performing in the past. You should continue to research Nexion Technologies to get a better picture of the stock by looking at: