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Are Educational Development Corporation's (NASDAQ:EDUC) Interest Costs Too High?

Simply Wall St

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Educational Development Corporation (NASDAQ:EDUC) is a small-cap stock with a market capitalization of US$73m. While investors primarily focus on the growth potential and competitive landscape of the small-cap companies, they end up ignoring a key aspect, which could be the biggest threat to its existence: its financial health. Why is it important? Understanding the company's financial health becomes vital, since poor capital management may bring about bankruptcies, which occur at a higher rate for small-caps. The following basic checks can help you get a picture of the company's balance sheet strength. Nevertheless, potential investors would need to take a closer look, and I suggest you dig deeper yourself into EDUC here.

EDUC’s Debt (And Cash Flows)

EDUC has shrunk its total debt levels in the last twelve months, from US$22m to US$20m , which includes long-term debt. With this reduction in debt, EDUC currently has US$7.8m remaining in cash and short-term investments to keep the business going. Additionally, EDUC has produced US$5.7m in operating cash flow over the same time period, resulting in an operating cash to total debt ratio of 29%, indicating that EDUC’s debt is appropriately covered by operating cash.

Does EDUC’s liquid assets cover its short-term commitments?

With current liabilities at US$26m, the company has been able to meet these obligations given the level of current assets of US$44m, with a current ratio of 1.68x. The current ratio is calculated by dividing current assets by current liabilities. Usually, for Retail Distributors companies, this is a suitable ratio since there's a sufficient cash cushion without leaving too much capital idle or in low-earning investments.

NasdaqGM:EDUC Historical Debt, May 3rd 2019

Can EDUC service its debt comfortably?

With debt reaching 78% of equity, EDUC may be thought of as relatively highly levered. This is a bit unusual for a small-cap stock, since they generally have a harder time borrowing than large more established companies. We can test if EDUC’s debt levels are sustainable by measuring interest payments against earnings of a company. Ideally, earnings before interest and tax (EBIT) should cover net interest by at least three times. For EDUC, the ratio of 8.93x suggests that interest is appropriately covered, which means that debtors may be willing to loan the company more money, giving EDUC ample headroom to grow its debt facilities.

Next Steps:

EDUC’s high cash coverage means that, although its debt levels are high, the company is able to utilise its borrowings efficiently in order to generate cash flow. This may mean this is an optimal capital structure for the business, given that it is also meeting its short-term commitment. Keep in mind I haven't considered other factors such as how EDUC has been performing in the past. I suggest you continue to research Educational Development to get a better picture of the small-cap by looking at:

  1. Future Outlook: What are well-informed industry analysts predicting for EDUC’s future growth? Take a look at our free research report of analyst consensus for EDUC’s outlook.
  2. Historical Performance: What has EDUC'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.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.