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Are BAE Systems plc’s (LON:BA.) Interest Costs Too High?

Julian Fleming

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BAE Systems plc (LON:BA.), a large-cap worth UK£17b, comes to mind for investors seeking a strong and reliable stock investment. Big corporations are much sought after by risk-averse investors who find diversified revenue streams and strong capital returns attractive. But, its financial health remains the key to continued success. This article will examine BAE Systems’s financial liquidity and debt levels to get an idea of whether the company can deal with cyclical downturns and maintain funds to accommodate strategic spending for future growth. Remember this is a very top-level look that focuses exclusively on financial health, so I recommend a deeper analysis into BA. here.

View our latest analysis for BAE Systems

Does BA. produce enough cash relative to debt?

BA. has sustained its debt level by about UK£4.2b over the last 12 months including long-term debt. At this current level of debt, the current cash and short-term investment levels stands at UK£2.3b for investing into the business. Additionally, BA. has generated cash from operations of UK£1.2b in the last twelve months, leading to an operating cash to total debt ratio of 28%, meaning that BA.’s current level of operating cash is high enough to cover debt. This ratio can also be a sign of operational efficiency as an alternative to return on assets. In BA.’s case, it is able to generate 0.28x cash from its debt capital.

Can BA. meet its short-term obligations with the cash in hand?

Looking at BA.’s UK£8.2b in current liabilities, the company may not have an easy time meeting these commitments with a current assets level of UK£7.9b, leading to a current ratio of 0.96x.

LSE:BA. Historical Debt February 11th 19

Does BA. face the risk of succumbing to its debt-load?

With debt reaching 71% of equity, BA. may be thought of as relatively highly levered. This isn’t uncommon for large companies because interest payments on debt are tax deductible, meaning debt can be a cheaper source of capital than equity. Accordingly, large companies often have an advantage over small-caps through lower cost of capital due to cheaper financing. By measuring how many times BA.’s earnings can cover interest payments, we can evaluate whether its level of debt is sustainable or not. A company generating earnings after interest and tax at least three times its net interest payments is considered financially sound. In BA.’s case, the ratio of 5.15x suggests that interest is well-covered. It is considered a responsible and reassuring practice to maintain high interest coverage, which makes BA. and other large-cap investments thought to be safe.

Next Steps:

BA.’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. Though its low liquidity raises concerns over whether current asset management practices are properly implemented for the large-cap. Keep in mind I haven’t considered other factors such as how BA. has been performing in the past. I suggest you continue to research BAE Systems to get a better picture of the stock by looking at:

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

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.