These 4 Measures Indicate That Educational Development (NASDAQ:EDUC) Is Using Debt Safely

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Educational Development Corporation (NASDAQ:EDUC) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Educational Development

What Is Educational Development's Debt?

As you can see below, Educational Development had US$11.2m of debt at August 2020, down from US$20.4m a year prior. But it also has US$22.6m in cash to offset that, meaning it has US$11.4m net cash.

How Strong Is Educational Development's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Educational Development had liabilities of US$37.9m due within 12 months and liabilities of US$11.7m due beyond that. Offsetting these obligations, it had cash of US$22.6m as well as receivables valued at US$3.27m due within 12 months. So its liabilities total US$23.7m more than the combination of its cash and short-term receivables.

Of course, Educational Development has a market capitalization of US$134.9m, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Educational Development boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Educational Development grew its EBIT by 67% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Educational Development will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Educational Development has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, Educational Development actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

Although Educational Development's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$11.4m. And it impressed us with free cash flow of US$33m, being 162% of its EBIT. So is Educational Development's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 1 warning sign for Educational Development you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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