How Financially Strong Is G8 Education Limited (ASX:GEM)?

Investors are always looking for growth in small-cap stocks like G8 Education Limited (ASX:GEM), with a market cap of AU$1.18B. However, an important fact which most ignore is: how financially healthy is the business? Assessing first and foremost the financial health is essential, since poor capital management may bring about bankruptcies, which occur at a higher rate for small-caps. Here are a few basic checks that are good enough to have a broad overview of the company’s financial strength. However, I know these factors are very high-level, so I recommend you dig deeper yourself into GEM here.

How does GEM’s operating cash flow stack up against its debt?

GEM has shrunken its total debt levels in the last twelve months, from AU$410.65M to AU$303.49M , which comprises of short- and long-term debt. With this reduction in debt, GEM's cash and short-term investments stands at AU$51.61M , ready to deploy into the business. Additionally, GEM has generated cash from operations of AU$92.01M during the same period of time, leading to an operating cash to total debt ratio of 30.32%, signalling that GEM’s current level of operating cash is high enough to cover debt. This ratio can also be interpreted as a measure of efficiency as an alternative to return on assets. In GEM’s case, it is able to generate 0.3x cash from its debt capital.

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

At the current liabilities level of AU$151.06M liabilities, it seems that the business has not maintained a sufficient level of current assets to meet its obligations, with the current ratio last standing at 0.61x, which is below the prudent industry ratio of 3x.

Can GEM service its debt comfortably?

With debt at 35.07% of equity, GEM may be thought of as appropriately levered. GEM is not taking on too much debt commitment, which can be restrictive and risky for equity-holders. We can test if GEM’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 GEM, the ratio of 5.08x suggests that interest is appropriately covered, which means that lenders may be inclined to lend more money to the company, as it is seen as safe in terms of payback.

Next Steps:

GEM’s debt level is appropriate for a company its size. Furthermore, it is able to generate sufficient cash flow coverage, meaning it is able to put its debt in good use. Though its lack of liquidity raises questions over current asset management practices for the small-cap. This is only a rough assessment of financial health, and I'm sure GEM has company-specific issues impacting its capital structure decisions. I recommend you continue to research G8 Education to get a more holistic view of the stock by looking at:

• 1. Future Outlook: What are well-informed industry analysts predicting for GEM’s future growth? Take a look at our free research report of analyst consensus for GEM’s outlook.
• 2. Valuation: What is GEM 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 GEM is currently mispriced by the market.
• 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.

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Simply Wall St analyst Simply Wall St and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.