The direct benefit for Sincere Watch (Hong Kong) Limited (HKG:444), 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 444 will have to adhere to stricter debt covenants and have less financial flexibility. Zero-debt can alleviate some risk associated with the company meeting debt obligations, but this doesn’t automatically mean 444 has outstanding financial strength. I will take you through a few basic checks to assess the financial health of companies with no debt.
Does 444’s growth rate justify its decision for financial flexibility over lower cost of capital?
Debt capital generally has lower cost of capital compared to equity funding. However, the trade-off is debtholders’ higher claim on company assets in the event of liquidation and stringent obligations around capital management. The lack of debt on 444’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 444 is a high-growth company. 444’s revenue growth over the past year is a single-digit 8.5% which is relatively low for a small-cap company. More capital can help the business grow faster. If 444 is not expecting exceptional future growth, then the decision to avoid may cost shareholders in the long term.
Can 444 pay its short-term liabilities?
Given zero long-term debt on its balance sheet, Sincere Watch (Hong Kong) 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. Looking at 444’s most recent HK$242m liabilities, it appears that the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 3.25x. Having said that, a ratio greater than 3x may be considered as quite high.
Having no debt on the books means 444 has more financial freedom to keep growing at its current fast rate. Since there is also no concerns around 444’s liquidity needs, this may be its optimal capital structure for the time being. Moving forward, 444’s financial situation may change. This is only a rough assessment of financial health, and I’m sure 444 has company-specific issues impacting its capital structure decisions. I recommend you continue to research Sincere Watch (Hong Kong) to get a more holistic view of the stock by looking at:
- Historical Performance: What has 444’s returns been like over the past? Go into more detail in the past track record analysis and take a look at the free visual representations of our analysis for more clarity.
- 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.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.