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Are Tesco PLC's (LON:TSCO) Interest Costs Too High?

Simply Wall St

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Tesco PLC (LON:TSCO), a large-cap worth UK£22b, comes to mind for investors seeking a strong and reliable stock investment. Risk-averse investors who are attracted to diversified streams of revenue and strong capital returns tend to seek out these large companies. However, the key to extending previous success is in the health of the company’s financials. I will provide an overview of Tesco’s financial liquidity and leverage to give you an idea of Tesco’s position to take advantage of potential acquisitions or comfortably endure future downturns. Note that this commentary is very high-level and solely focused on financial health, so I suggest you dig deeper yourself into TSCO here.

Check out our latest analysis for Tesco

Does TSCO Produce Much Cash Relative To Its Debt?

TSCO has shrunk its total debt levels in the last twelve months, from UK£8.6b to UK£7.3b – this includes long-term debt. With this reduction in debt, TSCO currently has UK£2.3b remaining in cash and short-term investments to keep the business going. Additionally, TSCO has produced UK£2.0b in operating cash flow over the same time period, resulting in an operating cash to total debt ratio of 27%, signalling that TSCO’s operating cash is sufficient to cover its debt.

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

With current liabilities at UK£21b, it seems that the business may not have an easy time meeting these commitments with a current assets level of UK£13b, leading to a current ratio of 0.61x. The current ratio is calculated by dividing current assets by current liabilities.

LSE:TSCO Historical Debt, June 28th 2019

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

With a debt-to-equity ratio of 49%, TSCO can be considered as an above-average leveraged company. This is not unusual for large-caps since debt tends to be less expensive than equity because interest payments are tax deductible. Accordingly, large companies often have lower cost of capital due to easily obtained financing, providing an advantage over smaller companies. We can assess the sustainability of TSCO’s debt levels to the test by looking at how well interest payments are covered by earnings. Preferably, earnings before interest and tax (EBIT) should be at least three times as large as net interest. For TSCO, the ratio of 7.73x suggests that interest is appropriately covered. Strong interest coverage is seen as a responsible and safe practice, which highlights why most investors believe large-caps such as TSCO is a safe investment.

Next Steps:

TSCO’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. But, its lack of liquidity raises questions over current asset management practices for the large-cap. Keep in mind I haven't considered other factors such as how TSCO has been performing in the past. I recommend you continue to research Tesco to get a better picture of the stock by looking at:

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