Large-cap companies such as BAE Systems plc (LSE:BA.), with a market-capitalization of £18.08B, are much sought after by risk-averse investors who find diversified revenue streams and strong capital returns more comforting than explosive growth potential. But another key factor to consider when investing in BA. is its financial health. There are always disruptions which destabilize an existing industry, and although large-caps are hard to knock down, it is useful to understand its level of resilience. Thus, it becomes utmost important for an investor to test a company’s resilience for such contingencies. In simple terms, I believe these three small calculations tell most of the story you need to know. View our latest analysis for BAE Systems
Can BA. service its debt comfortably?
A debt-to-equity ratio threshold varies depending on what industry the company operates, since some requires more debt financing than others. A ratio below 40% for large-cap stocks is considered as financially healthy, as a rule of thumb. In the case of BA., the debt-to-equity ratio is over 100%, which means that it is a highly leveraged company. This is not a problem if the company has consistently grown its profits. But during a business downturn, as liquidity may dry up, making it hard to operate. While debt-to-equity ratio has several factors at play, an easier way to check whether BA.’s leverage is at a sustainable level is to check its ability to service the debt. A company generating earnings (EBIT) at least three times its interest payments is considered financially sound. BA.’s interest on debt is sufficiently covered by earnings as it sits at around 3.99x. Debtors may be willing to loan the company more money, giving BA. ample headroom to grow its debt facilities.
How does BA.’s operating cash flow stack up against its debt?
A basic way to evaluate BA.’s debt management is to see whether the cash flow generated from the business is at a relatively high level compared to the debt capital invested. This also assesses BA.’s debt repayment capacity, which is not a big concern for a large company. In the case of BA., operating cash flow turned out to be 0.35x its debt level over the past twelve months. This is a good sign, as over a quarter of BA.’s near term debt can be covered by its day-to-day cash income, which reduces its riskiness to its debtholders.
Next Steps:
Are you a shareholder? BA.’s high debt level shouldn’t be an impetus for investors to sell given its high operating cash flow seems adequate to meet obligations which means its debt is being put to good use. Given that BA.’s financial position could change, I encourage examining market expectations for BA.’s future growth on our free analysis platform.