The direct benefit for Clear Media Limited (SEHK:100), 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 100 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 100’s financial health. View our latest analysis for Clear Media

Is 100 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 100 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. 100’s revenue growth over the past year is a single-digit 8.16% which is relatively 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.

Can 100 pay its short-term liabilities?

Given zero long-term debt on its balance sheet, Clear Media 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 100’s most recent CN¥681.3M liabilities, the company has been able to meet these commitments with a current assets level of CN¥1,386.1M, leading to a 2.03x current account ratio. Usually, for Media companies, this is a suitable ratio since there is a bit of a cash buffer without leaving too much capital in a low-return environment.

Next Steps:

As 100’s revenues are not growing at a fast enough pace, not taking advantage of lower cost debt may not be the best strategy. As an investor, you may want to figure out if there are company-specific reasons for not having any debt, and why financial flexibility is needed at this stage in its business cycle. I admit this is a fairly basic analysis for 100’s financial health. Other important fundamentals need to be considered alongside. You should continue to research Clear Media to get a more holistic view of the stock by looking at: