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Top Education Group Ltd (HKG:1752), 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 1752 will have to follow strict debt obligations which will reduce its financial flexibility. Zero-debt can alleviate some risk associated with the company meeting debt obligations, but this doesn’t automatically mean 1752 has outstanding financial strength. I will take you through a few basic checks to assess the financial health of companies with no debt.
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Is 1752 right in choosing financial flexibility over lower cost of capital?
Debt funding can be cheaper than issuing new equity due to lower interest cost on debt. 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. Either 1752 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. 1752’s revenue growth in the teens of 13% is not considered as high-growth, especially 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 1752’s liquid assets cover its short-term commitments?
Given zero long-term debt on its balance sheet, Top Education Group 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. Looking at 1752’s AU$7.2m in current liabilities, it seems that the business has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 6.78x. Having said that, a ratio above 3x may be considered excessive by some investors, yet this is not usually a major negative for a company.
Next Steps:
1752 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 1752’s liquidity needs, this may be its optimal capital structure for the time being. Going forward, 1752’s financial situation may change. Keep in mind I haven’t considered other factors such as how 1752 has been performing in the past. I suggest you continue to research Top Education Group to get a better picture of the stock by looking at: