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Does Fortescue Metals Group Limited's (ASX:FMG) Debt Level Pose A Problem?

Simply Wall St

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Fortescue Metals Group Limited (ASX:FMG), a large-cap worth AU$27b, 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. However, the health of the financials determines whether the company continues to succeed. Let’s take a look at Fortescue Metals Group’s leverage and assess its financial strength to get an idea of their ability to fund strategic acquisitions and grow through cyclical pressures. Remember this is a very top-level look that focuses exclusively on financial health, so I recommend a deeper analysis into FMG here.

Check out our latest analysis for Fortescue Metals Group

Does FMG Produce Much Cash Relative To Its Debt?

Over the past year, FMG has maintained its debt levels at around US$4.0b including long-term debt. At this stable level of debt, FMG's cash and short-term investments stands at US$962m to keep the business going. Additionally, FMG has produced cash from operations of US$2.1b in the last twelve months, resulting in an operating cash to total debt ratio of 53%, meaning that FMG’s current level of operating cash is high enough to cover debt.

Can FMG pay its short-term liabilities?

At the current liabilities level of US$1.5b, it seems that the business has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 1.36x. The current ratio is the number you get when you divide current assets by current liabilities. For Metals and Mining companies, this ratio is within a sensible range as there's enough of a cash buffer without holding too much capital in low return investments.

ASX:FMG Historical Debt, July 8th 2019

Is FMG’s debt level acceptable?

With a debt-to-equity ratio of 40%, FMG can be considered as an above-average leveraged company. This is common amongst large-cap companies because debt can often be a less expensive alternative to equity due to tax deductibility of interest payments. Accordingly, large companies often have lower cost of capital due to easily obtained financing, providing an advantage over smaller companies. We can check to see whether FMG is able to meet its debt obligations by looking at the net interest coverage ratio. Ideally, earnings before interest and tax (EBIT) should cover net interest by at least three times. In FMG's case, the ratio of 6.84x suggests that interest is well-covered. High interest coverage serves as an indication of the safety of a company, which highlights why many large organisations like FMG are considered a risk-averse investment.

Next Steps:

FMG’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. This may mean this is an optimal capital structure for the business, given that it is also meeting its short-term commitment. This is only a rough assessment of financial health, and I'm sure FMG has company-specific issues impacting its capital structure decisions. You should continue to research Fortescue Metals Group to get a more holistic view of the large-cap by looking at:

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

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.