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Zero-debt allows substantial financial flexibility, especially for small-cap companies like Takbo Group Holdings Limited (HKG:8436), as the company does not have to adhere to strict debt covenants. However, it also faces higher cost of capital given interest cost is generally lower than equity. 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.
Check out our latest analysis for Takbo Group Holdings
Is 8436 growing fast enough to value financial flexibility over 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. The lack of debt on 8436’s balance sheet may be because it does not have access to cheap capital, or it may believe this trade-off is not worth it. Choosing financial flexibility over capital returns make sense if 8436 is a high-growth company. A single-digit revenue growth of 3.0% for 8436 is considerably low for a small-cap company. While its low growth hardly justifies opting for zero-debt, the company may have high growth projects in the pipeline to justify the trade-off.
Does 8436’s liquid assets cover its short-term commitments?
Given zero long-term debt on its balance sheet, Takbo Group Holdings 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. With current liabilities at HK$19m, it seems that the business has been able to meet these commitments with a current assets level of HK$130m, leading to a 6.8x current account ratio. Having said that, anything above 3x may be considered excessive by some investors. They might argue 8436 is leaving too much capital in low-earning investments.
Next Steps:
Having no debt on the books means 8436 has more financial freedom to keep growing at its current fast rate. Since there is also no concerns around 8436’s liquidity needs, this may be its optimal capital structure for the time being. Moving forward, its financial position may change. I admit this is a fairly basic analysis for 8436’s financial health. Other important fundamentals need to be considered alongside. You should continue to research Takbo Group Holdings to get a better picture of the stock by looking at: