With a market capitalization of $10.06B, CF Industries Holdings Inc (NYSE:CF) falls in the category of stocks popularly identified as large-caps. These are established companies that attract investors due to diversified revenue streams and ability to enhance total returns through dividends. However, another important aspect of investing in large caps is its financial health. Why is it important? A major downturn in the energy industry has resulted in over 150 companies going bankrupt and has put more than 100 on the verge of a collapse, primarily due to excessive debt. Here are few basic financial health checks to judge whether a company fits the bill or there is an additional risk which you should consider before taking the plunge. See our latest analysis for CF Industries Holdings
Can CF service its debt comfortably?
Debt-to-equity ratio standards differ between industries, as some are more capital-intensive than others, meaning they need more capital to carry out core operations. Generally, large-cap stocks are considered financially healthy if its ratio is below 40%. In the case of CF, the debt-to-equity ratio is 92.72%, which indicates that the company is holding a high level of debt relative to its net worth. In the event of financial turmoil, the company may experience difficulty meeting interest and other debt obligations. While debt-to-equity ratio has several factors at play, an easier way to check whether CF’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. In CF’s case, its interest is not sufficiently covered by its profits as the ratio is 0.61x. Debtors may be less inclined to loan the company more money, giving CF less headroom for growth through debt.
Does CF generate enough cash through operations?
A basic way to evaluate CF’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 is also a test for whether CF has the ability to repay its debt with cash from its business, which is less of a concern for large companies. Last year, CF’s operating cash flow was 0.25x its current debt. This means, over a tenth of CF’s near term debt can be covered by its day-to-day cash income, which somewhat reduces its riskiness to its debtholders.
Are you a shareholder? With a high level of debt on its balance sheet, CF could still be in a financially strong position if its cash flow also stacked up. However, this isn’t the case so investors should ask themselves if they believe CF can sustainably increase its operational efficiency going forward. Given that CF’s financial situation may change, You should continue researching market expectations for CF’s future growth on our free analysis platform.
Are you a potential investor? Although understanding the serviceability of debt is important when evaluating which companies are viable investments, it shouldn’t be the deciding factor. Ultimately, debt financing is an important source of funding for companies seeking to grow through new projects and investments. So, I recommend potential investors to assess CF’s Return on Capital Employed (ROCE) in order to see management’s track record at deploying funds in high-returning projects.
To help readers see pass 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.