The direct benefit for Hailiang Education Group Inc. (NASDAQ:HLG), 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 HLG will have to adhere to stricter debt covenants and have less financial flexibility. While HLG has no debt on its balance sheet, it doesn’t necessarily mean it exhibits financial strength. I will go over a basic overview of the stock’s financial health, which I believe provides a ballpark estimate of their financial health status.
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Is financial flexibility worth the 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 HLG 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 double-digit revenue growth of 37% is considered relatively high for a small-cap company like HLG. So, it is acceptable that the company is opting for a zero-debt capital structure currently as it may need to raise debt to fuel expansion in the future.
Can HLG pay its short-term liabilities?
Given zero long-term debt on its balance sheet, Hailiang 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 HLG’s CN¥550m in current liabilities, it appears that the company has been able to meet these commitments with a current assets level of CN¥1.1b, leading to a 2.05x current account ratio. For Consumer Services companies, this ratio is within a sensible range since there is a bit of a cash buffer without leaving too much capital in a low-return environment.
HLG 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 HLG’s liquidity needs, this may be its optimal capital structure for the time being. Moving forward, its financial position may be different. This is only a rough assessment of financial health, and I’m sure HLG has company-specific issues impacting its capital structure decisions. I recommend you continue to research Hailiang Education Group to get a more holistic view of the stock by looking at:
- Future Outlook: What are well-informed industry analysts predicting for HLG’s future growth? Take a look at our free research report of analyst consensus for HLG’s outlook.
- Valuation: What is HLG worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether HLG is currently mispriced by the market.
- Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
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