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The direct benefit for Sinostar PEC Holdings Limited (SGX:C9Q), 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 C9Q 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 recommend you look at the following hurdles to assess C9Q’s financial health.
See our latest analysis for Sinostar PEC Holdings
Is C9Q 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. 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 C9Q 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. A revenue growth in the teens is not considered high-growth. C9Q’s revenue growth of 17.9% falls into this range. More capital can help the business grow faster. If C9Q is not expecting exceptional future growth, then the decision to avoid may cost shareholders in the long term.
Can C9Q pay its short-term liabilities?
Given zero long-term debt on its balance sheet, Sinostar PEC 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. At the current liabilities level of CN¥44.8m liabilities, it appears that the company has been able to meet these commitments with a current assets level of CN¥655.0m, leading to a 14.62x current account ratio. However, anything above 3x is considered high and could mean that C9Q has too much idle capital in low-earning investments.
Next Steps:
As a high-growth company, it may be beneficial for C9Q to have some financial flexibility, hence zero-debt. This may mean this is an optimal capital structure for the business, given that it is also meeting its short-term commitment. Moving forward, its financial position may be different. I admit this is a fairly basic analysis for C9Q’s financial health. Other important fundamentals need to be considered alongside. I recommend you continue to research Sinostar PEC Holdings to get a better picture of the stock by looking at: