Are Fortescue Metals Group Limited’s (ASX:FMG) Interest Costs Too High?

Investors seeking to preserve capital in a volatile environment might consider large-cap stocks such as Fortescue Metals Group Limited (ASX:FMG) a safer option. Doing business globally, large caps tend to have diversified revenue streams and attractive capital returns, making them desirable investments for risk-averse portfolios. 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. Note that this information is centred entirely on financial health and is a high-level overview, so I encourage you to look further into FMG here.

Check out our latest analysis for Fortescue Metals Group

Does FMG Produce Much Cash Relative To Its Debt?

FMG’s debt level has been constant at around US$4.0b over the previous year which accounts for long term debt. At this current level of debt, FMG’s cash and short-term investments stands at US$962m , ready to be used for running the business. Additionally, FMG has produced cash from operations of US$2.1b over the same time period, leading to an operating cash to total debt ratio of 53%, indicating that FMG’s operating cash is sufficient to cover its debt.

Can FMG pay its short-term liabilities?

Looking at FMG’s US$1.5b in current liabilities, 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 calculated by dividing current assets by current liabilities. Usually, for Metals and Mining companies, this is a suitable ratio as there’s enough of a cash buffer without holding too much capital in low return investments.

ASX:FMG Historical Debt, April 22nd 2019
ASX:FMG Historical Debt, April 22nd 2019

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

FMG is a relatively highly levered company with a debt-to-equity of 40%. This isn’t surprising for large-caps, as equity can often be more expensive to issue than debt, plus interest payments are tax deductible. Consequently, larger-cap organisations tend to enjoy lower cost of capital as a result of easily attained financing, providing an advantage over smaller companies. The sustainability of FMG’s debt levels can be assessed by comparing the company’s interest payments to earnings. Preferably, earnings before interest and tax (EBIT) should be at least three times as large as net interest. For FMG, 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:

Although FMG’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. Since there is also no concerns around FMG’s liquidity needs, this may be its optimal capital structure for the time being. This is only a rough assessment of financial health, and I’m sure FMG has company-specific issues impacting its capital structure decisions. I suggest you continue to research Fortescue Metals Group to get a better picture 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.