Zero-debt allows substantial financial flexibility, especially for small-cap companies like REF Holdings Limited (SEHK:1631), as the company does not have to adhere to strict debt covenants. However, it also faces higher cost of capital given interest cost is generally lower than equity. While 1631 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 REF Holdings
Is 1631 right in choosing financial flexibility over lower cost of capital?
Debt capital generally has lower cost of capital compared to equity funding. But the downside of having debt in a company’s balance sheet is the debtholder’s higher claim on its assets in the case of liquidation, as well as stricter capital management requirements. Either 1631 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. 1631’s revenue growth over the past year is a double-digit 25.11% which is considerably high for a small-cap company. 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 1631 pay its short-term liabilities?
Since REF Holdings doesn’t have any debt on its balance sheet, it doesn’t have any solvency issues, which is a term 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$46.16M 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 3.28x. Though, a ratio greater than 3x may be considered as too high, as 1631 could be holding too much capital in a low-return investment environment.
Given that REF Holdings is a relatively low-growth company, not taking advantage of lower cost debt may not be the best strategy. As shareholders, you should try and determine whether this strategy is justified for 1631, and whether the company needs financial flexibility at this point in time. Keep in mind I haven’t considered other factors such as how 1631 has been performing in the past. You should continue to research REF Holdings to get a better picture of the stock by looking at:
- 1. Valuation: What is 1631 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 1631 is currently mispriced by the market.
- 2. Historical Performance: What has 1631’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.
- 3. 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 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.