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Are Phillips 66's (NYSE:PSX) Interest Costs Too High?

Simply Wall St

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The size of Phillips 66 (NYSE:PSX), a US$45b large-cap, often attracts investors seeking a reliable investment in the stock market. 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. Let’s take a look at Phillips 66’s leverage and assess its financial strength to get an idea of their ability to fund strategic acquisitions and grow through cyclical pressures. Note that this commentary is very high-level and solely focused on financial health, so I suggest you dig deeper yourself into PSX here.

See our latest analysis for Phillips 66

PSX’s Debt (And Cash Flows)

Over the past year, PSX has ramped up its debt from US$10b to US$11b , which accounts for long term debt. With this growth in debt, PSX currently has US$3.0b remaining in cash and short-term investments , ready to be used for running the business. Moreover, PSX has produced US$7.6b in operating cash flow over the same time period, resulting in an operating cash to total debt ratio of 68%, meaning that PSX’s debt is appropriately covered by operating cash.

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

With current liabilities at US$8.9b, the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 1.48x. 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 since there is a bit of a cash buffer without leaving too much capital in a low-return environment.

NYSE:PSX Historical Debt, April 9th 2019

Is PSX’s debt level acceptable?

PSX is a relatively highly levered company with a debt-to-equity of 41%. 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. Since large-caps are seen as safer than their smaller constituents, they tend to enjoy lower cost of capital. We can assess the sustainability of PSX’s debt levels to the test by looking at how well interest payments are covered by earnings. A company generating earnings before interest and tax (EBIT) at least three times its net interest payments is considered financially sound. In PSX's case, the ratio of 11.23x suggests that interest is amply covered. It is considered a responsible and reassuring practice to maintain high interest coverage, which makes PSX and other large-cap investments thought to be safe.

Next Steps:

PSX’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 PSX has company-specific issues impacting its capital structure decisions. You should continue to research Phillips 66 to get a more holistic view of the large-cap by looking at:

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