SUTL Enterprise Limited (SGX:BHU), 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 BHU will have to follow strict debt obligations which will reduce its 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 BHU’s financial health.

See our latest analysis for SUTL Enterprise

Is financial flexibility worth the lower cost of capital?

There are well-known benefits of including debt in capital structure, primarily a lower cost of capital. Though, the trade-offs are that lenders require stricter capital management requirements, in addition to having a higher claim on company assets relative to shareholders. BHU’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. Opposite to the high growth we were expecting, BHU’s negative revenue growth of -9.0% hardly justifies opting for zero-debt. If the decline sustains, it may find it hard to raise debt at an acceptable cost.

Can BHU pay its short-term liabilities?

Since SUTL Enterprise 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 BHU’s S$11m in current liabilities, it seems that the business has been able to meet these commitments with a current assets level of S$49m, leading to a 4.36x current account ratio. However, many consider a ratio above 3x to be high, although this is not necessarily a bad thing.

Next Steps:

As a high-growth company, it may be beneficial for BHU to have some financial flexibility, hence zero-debt. Since there is also no concerns around BHU’s liquidity needs, this may be its optimal capital structure for the time being. Moving forward, BHU’s financial situation may change. Keep in mind I haven’t considered other factors such as how BHU has been performing in the past. I suggest you continue to research SUTL Enterprise to get a better picture of the stock by looking at: