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Are Peabody Energy Corporation's (NYSE:BTU) Interest Costs Too High?

Simply Wall St

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Peabody Energy Corporation (NYSE:BTU) is a small-cap stock with a market capitalization of US$2.6b. While investors primarily focus on the growth potential and competitive landscape of the small-cap companies, they end up ignoring a key aspect, which could be the biggest threat to its existence: its financial health. Why is it important? Evaluating financial health as part of your investment thesis is essential, as mismanagement of capital can lead to bankruptcies, which occur at a higher rate for small-caps. We'll look at some basic checks that can form a snapshot the company’s financial strength. However, potential investors would need to take a closer look, and I recommend you dig deeper yourself into BTU here.

BTU’s Debt (And Cash Flows)

BTU's debt level has been constant at around US$1.5b over the previous year including long-term debt. At this stable level of debt, BTU's cash and short-term investments stands at US$798m , ready to be used for running the business. On top of this, BTU has produced cash from operations of US$1.1b over the same time period, leading to an operating cash to total debt ratio of 76%, meaning that BTU’s current level of operating cash is high enough to cover debt.

Does BTU’s liquid assets cover its short-term commitments?

Looking at BTU’s US$1.0b in current liabilities, the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 1.77x. The current ratio is the number you get when you divide current assets by current liabilities. Usually, for Oil and Gas companies, this is a suitable ratio as there's enough of a cash buffer without holding too much capital in low return investments.

NYSE:BTU Historical Debt, June 27th 2019

Is BTU’s debt level acceptable?

With debt reaching 42% of equity, BTU may be thought of as relatively highly levered. This is somewhat unusual for small-caps companies, since lenders are often hesitant to provide attractive interest rates to less-established businesses. We can check to see whether BTU is able to meet its debt obligations by looking at the net interest coverage ratio. A company generating earnings before interest and tax (EBIT) at least three times its net interest payments is considered financially sound. In BTU's, case, the ratio of 4.43x suggests that interest is appropriately covered, which means that debtors may be willing to loan the company more money, giving BTU ample headroom to grow its debt facilities.

Next Steps:

Although BTU’s debt level is towards the higher end of the spectrum, its cash flow coverage seems adequate to meet obligations which means its debt is being efficiently utilised. 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 BTU has company-specific issues impacting its capital structure decisions. I suggest you continue to research Peabody Energy to get a more holistic view of the small-cap by looking at:

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