Is Mega Expo Holdings Limited (HKG:1360) As Financially Strong As Its Balance Sheet Indicates?
The direct benefit for Mega Expo Holdings Limited (SEHK:1360), 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 1360 will have to adhere to stricter debt covenants and have less financial flexibility. While 1360 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. View our latest analysis for Mega Expo Holdings
Is financial flexibility worth the 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. 1360’s absence of debt on its balance sheet may be due to lack of access to cheaper capital, or it may simply believe low cost is not worth sacrificing financial flexibility. However, choosing flexibility over capital returns is logical only if it’s a high-growth company. Opposite to the high growth we were expecting, 1360’s negative revenue growth of -36.07% hardly justifies opting for zero-debt. If the decline sustains, it may find it hard to raise debt at an acceptable cost.
Can 1360 pay its short-term liabilities?
Given zero long-term debt on its balance sheet, Mega Expo 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. At the current liabilities level of HK$28.3M liabilities, the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 4.27x. However, anything about 3x may be excessive, since 1360 may be leaving too much capital in low-earning investments.
Next Steps:
Are you a shareholder? Given that Mega Expo Holdings is a relatively low-growth company, not having any low-cost debt funding may not be optimal for the business. Shareholders should understand why the company isn’t opting for cheaper cost of capital to fund future growth, and whether the company needs financial flexibility at this point in time. I recommend taking a look into a future growth analysis to account for what the market expects for the company moving forward.
Are you a potential investor? The company’s current holding of liquid assets gives it some level of security in any case of adverse events. Though, a relatively low revenue growth means there’s potential to improve return on capital by taking on some debt and ramp up growth. This is only a rough assessment of financial health, and I’m sure 1360 has company-specific issues impacting its capital structure decisions. You should continue your analysis by taking a look at 1360’s past performance to conclude on 1360’s financial health.
To help readers see pass 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.
