Mid-caps stocks, like Qantas Airways Limited (ASX:QAN) with a market capitalization of AUD A$9.35B, aren’t the focus of most investors who prefer to direct their investments towards either large-cap or small-cap stocks. Surprisingly though, when accounted for risk, mid-caps have delivered better returns compared to the two other categories of stocks. Mid-caps are found to be more volatile than the large-caps but safer than small-caps, largely due to their weaker balance sheet. I will take you through a few basic checks to assess the financial health of companies with no debt. Check out our latest analysis for Qantas Airways
Is QAN’s level of debt at an acceptable level?
While ideally the debt-to equity ratio of a financially healthy company should be less than 40%, several factors such as industry life-cycle and economic conditions can result in a company raising a significant amount of debt. In the case of QAN, 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, availability of cash may dry up, making it hard to operate. No matter how high the company’s debt, if it can easily cover the interest payments, it’s considered to be efficient with its use of excess leverage. A company generating earnings (EBIT) at least three times its interest payments is considered financially sound. QAN’s profits amply covers interest at 8.66 times, which is seen as relatively safe. Debtors may be willing to loan the company more money, giving QAN ample headroom to grow its debt facilities.
Can QAN meet its short-term obligations with the cash in hand?
Debt to equity ratio is an important aspect of financial strength. But if the company has a substantial amount of cash on its balance sheet, that should allay some fear of a debt overhang and increase the chance of meeting upcoming liabilities. We need to assess QAN’s cash and other liquid assets against its upcoming expenses. Our analysis shows that QAN is unable to meet all of its upcoming commitments with its cash and other short-term assets. While this is not abnormal for companies, as their cash is better invested in the business or returned to investors than lying around, it does bring about some concerns should any unfavourable circumstances arise.
Next Steps:
Are you a shareholder? QAN’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 QAN’s capital structure could change, I encourage exploring market expectations for QAN’s future growth on our free analysis platform.