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The direct benefit for Sino Splendid Holdings Limited (HKG:8006), 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 8006 will have to adhere to stricter debt covenants and have less financial flexibility. 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 will take you through a few basic checks to assess the financial health of companies with no debt.
See our latest analysis for Sino Splendid Holdings
Is 8006 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. 8006’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. 8006 delivered a negative revenue growth of -3.3%. While its negative growth hardly justifies opting for zero-debt, if the decline sustains, it may find it hard to raise debt at an acceptable cost.
Can 8006 meet its short-term obligations with the cash in hand?
Since Sino Splendid Holdings 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. 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. Looking at 8006’s most recent HK$33m liabilities, it appears that the company has been able to meet these obligations given the level of current assets of HK$145m, with a current ratio of 4.44x. However, a ratio greater than 3x may be considered as quite high, and some might argue 8006 could be holding too much capital in a low-return investment environment.
Next Steps:
Having no debt on the books means 8006 has more financial freedom to keep growing at its current fast rate. Since there is also no concerns around 8006’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 8006 has been performing in the past. You should continue to research Sino Splendid Holdings to get a better picture of the stock by looking at: