The direct benefit for Yirendai Ltd (NYSE:YRD), 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 YRD 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 YRD has outstanding financial strength. I recommend you look at the following hurdles to assess YRD’s financial health.
Is YRD growing fast enough to value financial flexibility over lower cost of capital?
There are well-known benefits of including debt in capital structure, primarily a lower cost of capital. 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 YRD 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. YRD delivered a strikingly high revenue growth of 58% over the past year. Therefore, the company’s decision to choose financial flexibility is justified as it may need headroom to borrow in the future to sustain high growth.
Can YRD meet its short-term obligations with the cash in hand?
Since Yirendai 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 CN¥1.3b liabilities, it appears that the company has been able to meet these obligations given the level of current assets of CN¥6.8b, with a current ratio of 5.13x. Having said that, many consider anything above 3x to be quite high and could mean that YRD has too much idle capital in low-earning investments.
As a high-growth company, it may be beneficial for YRD to have some financial flexibility, hence zero-debt. This may mean this is an optimal capital structure for the business, given that it is also meeting its short-term commitment. Moving forward, YRD’s financial situation may change. Keep in mind I haven’t considered other factors such as how YRD has been performing in the past. I suggest you continue to research Yirendai to get a better picture of the stock by looking at:
- Future Outlook: What are well-informed industry analysts predicting for YRD’s future growth? Take a look at our free research report of analyst consensus for YRD’s outlook.
- Valuation: What is YRD 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 YRD 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.
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.
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