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The direct benefit for Crownia Holdings Ltd. (CVE:CNH), 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 CNH 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 CNH has outstanding financial strength. I will take you through a few basic checks to assess the financial health of companies with no debt.
Is CNH growing fast enough to value financial flexibility over 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. CNH’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. CNH delivered a negative revenue growth of -96%. While its negative growth hardly justifies opting for zero-debt, if the decline sustains, it may find it hard to raise debt at an acceptable cost.
Does CNH’s liquid assets cover its short-term commitments?
Since Crownia 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 US$502k, the company has been able to meet these obligations given the level of current assets of US$1.1m, with a current ratio of 2.24x. Usually, for Trade Distributors companies, this is a suitable ratio as there’s enough of a cash buffer without holding too much capital in low return investments.
Since CNH is a low-growth stock in terms of its revenues, not having any low-cost debt funding may not be optimal for the business. As shareholders, you should try and determine whether this strategy is justified for CNH, and whether the company needs financial flexibility at this point in time. Keep in mind I haven’t considered other factors such as how CNH has been performing in the past. You should continue to research Crownia Holdings to get a better picture of the stock by looking at:
- Valuation: What is CNH 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 CNH is currently mispriced by the market.
- Historical Performance: What has CNH’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 firstname.lastname@example.org.