While small-cap stocks, such as RISE Education Cayman Ltd (NASDAQ:REDU) with its market cap of US$894.60M, are popular for their explosive growth, investors should also be aware of their balance sheet to judge whether the company can survive a downturn. Given that REDU is not presently profitable, it’s crucial to assess the current state of its operations and pathway to profitability. I believe these basic checks tell most of the story you need to know. Though, this commentary is still very high-level, so I suggest you dig deeper yourself into REDU here.

Does REDU generate an acceptable amount of cash through operations?

Over the past year, REDU has ramped up its debt from CN¥371.29M to CN¥623.44M – this includes both the current and long-term debt. With this growth in debt, REDU currently has CN¥1.07B remaining in cash and short-term investments , ready to deploy into the business. Additionally, REDU has generated cash from operations of CN¥345.27M in the last twelve months, resulting in an operating cash to total debt ratio of 55.38%, signalling that REDU’s operating cash is sufficient to cover its debt. This ratio can also be a sign of operational efficiency for unprofitable companies since metrics such as return on asset (ROA) requires positive earnings. In REDU’s case, it is able to generate 0.55x cash from its debt capital.

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

At the current liabilities level of CN¥1.03B liabilities, it seems that the business has been able to meet these commitments with a current assets level of CN¥1.14B, leading to a 1.11x current account ratio. Generally, for Consumer Services companies, this is a reasonable ratio as there’s enough of a cash buffer without holding too capital in low return investments.

Is REDU’s debt level acceptable?

Since total debt levels have outpaced equities, REDU is a highly leveraged company. This is not unusual for small-caps as debt tends to be a cheaper and faster source of funding for some businesses. But since REDU is currently loss-making, there’s a question of sustainability of its current operations. Maintaining a high level of debt, while revenues are still below costs, can be dangerous as liquidity tends to dry up in unexpected downturns.

Next Steps:

REDU’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. Since there is also no concerns around REDU’s liquidity needs, this may be its optimal capital structure for the time being. This is only a rough assessment of financial health, and I’m sure REDU has company-specific issues impacting its capital structure decisions. You should continue to research RISE Education Cayman to get a more holistic view of the small-cap by looking at: