Gaining knowledge about a company's debt and liabilities is a key component in understanding the risk of a company. An understanding of these factors will aid in the decision to invest, not to invest, or to stay invested in a company. There are many metrics involved in gaining knowledge about the debt of a company, but for this article, I will look at Barrick Gold Corporation's (ABX) total debt, total liabilities, debt ratios and WACC.
1. Total Debt = Long-Term Debt + Short-Term Debt
Total debt is the sum of long-term debt, which is debt that is due in one year or more, and short-term debt, which is any debt that is due within one year.
- 2008 - $4.350 billion + $206 million = $4.556 billion
- 2009 - $6.124 billion + $54 million = $6.178 billion
- 2010 - $6.624 billion + $14 million = $6.638 billion
- 2011 - $13.173 billion + $196 million = $13.369 billion
- 2012 TTM - $12.642 billion + $1.299 billion = $13.941 billion
Barrick Gold's total debt has increased since 2008. In 2008, the company reported a total debt of $4.556 billion. In 2012 TTM, the company's total debt increased to $13.941 billion. Over the past 5 years, Barrick Gold's total debt has increased by 305.99%.
2. Total Liabilities
Liabilities are a company's legal debts or obligations that arise during the course of business operations, so debts are one type of liability, but not all liabilities. Total liabilities is the combination of long-term liabilities, which are the liabilities that are due in one year or more, and short-term or current liabilities, which are any liabilities due within one year.
- 2008 - $8.702 billion
- 2009 - $11.528 billion
- 2010 - $13.420 billion
- 2011 - $23.330 billion
- 2012 TTM - $26.912 billion
Barrick Gold's liabilities have also increased over the past 5 years. In 2008, the company reported liabilities at $8.702 billion; in 2012 TTM, the company reported liabilities at $26.912 billion. Over the past 5 years, Barrick Gold's liabilities have increased by 309.26%.
In analyzing Barrick Gold's total debt and liabilities, we can see that the company currently has a total debt of $13.941 billion and liabilities at $26.912 billion. Over the past five years, the total debt has increased by 305.99% while total liabilities have increased by 309.26%. As the company's amount of debt and amount of liabilities have increased over the past 5 years, the next step will reveal if the company has the ability to pay them.
3. Total Debt to Total Assets Ratio = Total Debt / Total Assets
This is a metric used to measure a company's financial risk by determining how much of the company's assets have been financed by debt. It is calculated by adding short-term and long-term debt and then dividing by the company's total assets.
A debt ratio of greater than 1 indicates that a company has more total debt than assets; meanwhile, a debt ratio of less than 1 indicates that a company has more assets than total debt. Used along with other measures of financial health, the total debt to total assets ratio can help investors determine a company's level of risk.
- 2010 - $6.638 billion / $34.637 billion = 0.19
- 2011 - $13.369 billion / $48.884 billion = 0.27
- 2012 TTM - $13.941 billion / $52.084 billion = 0.27
Over the past three years, Barrick Gold's total debt to total assets ratio has increased. Over the past 3 years, the total debt to total assets ratio has increased from 0.19 in 2010 to 0.27 in 2012 TTM. This indicates that since 2010, the company has been adding asset value at a slower rate than its total debt. As the number is currently well below 1, this indicates that the company has more assets than total debt. As the number has been increasing, this states that the risk to the company regarding its debt-to-assets has increased since 2010.
4. Debt ratio = Total Liabilities / Total Assets
Total liabilities divided by total assets. The debt ratio shows the proportion of a company's assets that is financed through debt. If the ratio is less than 0.5, most of the company's assets are financed through equity. If the ratio is greater than 0.5, most of the company's assets are financed through debt. Companies with high debt/asset ratios are said to be "highly leveraged." A company with a high-debt ratio or that is "highly leveraged" could be in danger if creditors start to demand repayment of debt.
- 2010 - $13.420 billion / $34.637 billion = 0.39
- 2011 - $23.330 billion / $48.884 billion = 0.48
- 2012 TTM - $26.912 billion / $52.084 billion = 0.52
In looking at Barrick Gold's total liabilities to total assets ratio over the past three years, we can see that this ratio has increased. The ratio has increased from 0.39 in 2010 to 0.52 in 2012 TTM. As the 2012 TTM numbers are above the 0.50 mark, this indicates that Barrick Gold has financed most of the company's assets through debt. As the number has increased, so is the risk to the company.
5. Debt-to-Equity Ratio = Total Liabilities / Shareholders' Equity
The debt-to-equity ratio is another leverage ratio that compares a company's total liabilities with its total shareholders' equity. This is a measurement of how much suppliers, lenders, creditors and obligators have committed to the company versus what the shareholders have committed.
A high debt-to-equity ratio generally means that a company has been aggressive in financing its growth with debt. This can result in the company reporting volatile earnings. In general, a high debt-to-equity ratio indicates that a company may not be able to generate enough cash to satisfy its debt obligations, and therefore is considered a riskier investment.
- 2010 - $13.420 billion / $21.217 billion = 0.63
- 2011 - $23.330 billion / $25.554 billion = 0.91
- 2012 TTM - $26.912 billion / $25.172 billion = 1.07
Compared to 2010, Barrick Gold's debt-to-equity ratio has increased. The ratio has increased from 0.63 to 1.07. As the ratio is currently above 1, this indicates that suppliers, lenders, creditors and obligators have invested more than shareholders. 1.07 indicates a moderate amount of risk for the company. As the ratio is above 1 and considered moderate, so is the risk for the company.
6. Capitalization Ratio = LT Debt / LT Debt + Shareholders' Equity
(LT Debt = Long-Term Debt)
The capitalization ratio tells the investors about the extent to which the company is using its equity to support its operations and growth. This ratio helps in the assessment of risk. Companies with a high capitalization ratio are considered to be risky because they are at a risk of insolvency if they fail to repay their debt on time. Companies with a high capitalization ratio may also find it difficult to get more loans in the future.
- 2010 - $6.624 billion / $27.841 billion = 0.24
- 2011 - $13.173 billion / $38.727 billion = 0.34
- 2012 TTM - $12.642 billion / $37.814 billion = 0.33
Over the past three years, Barrick Gold's capitalization ratio has increased from 0.24 to 0.33. This implies that the company has less equity compared with its long-term debt. As this is the case, the company has had less equity to support its operations and add growth through its equity. As the ratio is increasing, financially this implies a slight increase of risk to the company.
7. Cash Flow to Total Debt Ratio = Operating Cash Flow / Total Debt
This coverage ratio compares a company's operating cash flow with its total debt. This ratio provides an indication of a company's ability to cover total debt with its yearly cash flow from operations. The higher the percentage ratio, the better the company's ability to carry its total debt. The larger the ratio, the better a company can weather rough economic conditions.
- 2010 - $4.127 billion / $6.638 billion = 0.62
- 2011 - $5.315 billion / $13.369 billion = 0.40
- 2012 TTM - $4.991 billion / $13.941 billion = 0.36
Over the past three years, the cash flow to total debt ratio has decreased. The ratio has decreased from 0.62 in 2010 to 0.36 in 2012 TTM. As the ratio is below 1, this implies that the company does not have the ability to cover its total debt with its yearly cash flow from operations.
Based on the five debt ratios listed above, we can see that Barrick Gold has increased its risk regarding the company's debt and liabilities. The above ratio state that there has been an increase in the company's debt levels compared to the company's assets but the ratios are below any red flag levels. As the price of gold looks to be strong in 2013, the company should be able to make money on the assets, thus making the increase of debt and liabilities worthwhile. The next step will reveal how much the company will pay for the debt incurred.
Cost of Debt
The cost of debt is the effective rate that a company pays on its total debt.
As a company acquires debt through various bonds, loans and other forms of debt, the cost of debt metric is useful, because it gives an idea as to the overall rate being paid by the company to use debt financing.
This measure is also useful because it gives investors an idea as to the riskiness of the company compared with others. The higher the cost of debt, the higher the risk.
8. Cost of debt (before tax) = Corporate Bond rate of company's bond rating.
- S&P rated Barrick Gold's bonds "BBB+"
- Current 20-year corporate bond Rate of "BBB" = 6.69%
- Current cost of Debt as of January 29th 2013 = 6.69%
According to the S&P rating guide, the "BBB+" rating is - "Adequate capacity to meet financial commitments, but more subject to adverse economic conditions." Barrick Gold has a rating that meets this description.
9. Current tax rate (Income Tax total / Income before Tax)
- 2008 - $590 million / $1.451 billion = 40.66%
- 2009 - $648 million / $(3.630) billion = 17.85%
- 2010 - $1.370 billion / $4.587 billion = 29.87%
- 2011 - $1.867 billion / $6.824 billion = 27.36%
- 2012 TTM - $1.867 billion / $5.241 billion = 35.62%
2008 - 2012 TTM 5-year average = 33.37%
From 2008 - 2012 TTM, Barrick Gold has averaged a tax rate of 33.37%.
10. Cost of Debt (After Tax) = (Cost of debt before tax) (1 - tax rate)
The effective rate that a company pays on its current debt after tax.
- .0669 x (1 - .3337) = Cost of debt after tax
The cost of debt after tax for Barrick Gold is 4.46%
Cost of equity or R equity = Risk free rate + Beta equity (Average market return - Risk free rate)
The cost of equity is the return a firm theoretically pays to its equity investors, for example, shareholders, to compensate for the risk they undertake by investing in their company.
- Risk free rate = U.S. 10-year bond = 1.96% (Bloomberg)
- Average market return 1950 - 2012 = 7%
- Beta = (MSN Money) Barrick Gold beta = 0.45
Risk free rate + Beta equity (Average market return - Risk free rate)
- 1.96 + 0.45 (7-1.96)
- 1.96 + 0.45 x 5.04
- 1.96 + 2.27 = 4.23%
Currently, Barrick Gold has a cost of equity or R Equity of 4.23%, so investors should expect to get a return of 4.23% per-year average over the long term on their investment to compensate for the risk they undertake by investing in this company.
(Please note that this is the CAPM approach to finding the cost of equity. Inherently, there are some flaws with this approach and that the numbers are very "general." This approach is based off of the S&P average return from 1950 - 2012 at 7%, the U.S. 10-year bond for the risk-free rate which is susceptible to daily change and Google finance beta.)
Weighted Average Cost of Capital or WACC
The WACC calculation is a calculation of a company's cost of capital in which each category of capital is equally weighted. All capital sources such as common stock, preferred stock, bonds and all other long-term debt are included in this calculation.
As the WACC of a firm increases, and the beta and rate of return on equity increases, this states a decrease in valuation and a higher risk.
By taking the weighted average, we can see how much interest the company has to pay for every dollar it finances.
For this calculation, you will need to know the following listed below:
Tax Rate = 33.37% (Barrick Gold's five-year average Tax Rate)
Cost of Debt (before tax) or R debt = 6.69%
Cost of Equity or R equity = 4.23%
Debt (Total Liabilities) for 2012 TTM or D = $26.912 billion
Stock Price = $32.55 (January 29th, 2013)
Outstanding Shares = 1.00 billion
Equity = Stock price x Outstanding Shares or E = $32.550 billion
Debt + Equity or D+E = $59.462 billion
WACC = R = (1 - Tax Rate) x R debt (D/D+E) + R equity (E/D+E)
(1 - Tax Rate) x R debt (D/D+E) + R equity (E/D+E)
(1 - .3337) x .0385 x ($26.912/$59.462) + .0669 ($32.550/$59.462)
.6663 x .0385 x .4526 + .0669 x .5474
.0116 + .0366
Based on the calculations above, we can conclude that Barrick Gold pays 4.82% on every dollar that it finances, or 4.82 cents on every dollar. From this calculation, we understand that on every dollar the company spends on an investment, the company must make $.0482 plus the cost of the investment for the investment to be feasible for the company.
Looking at the numbers of Barrick Gold's total debt and liabilities, we can see that the company currently has a total debt of $13.941 billion and liabilities at $26.912 billion. Over the past five years, the total debt has increased by 305.99% while total liabilities have increased by 309.26%.
Analyzing the ratios listed above, we can see that Barrick Gold has increased its risk regarding the company's debt and liabilities. The above ratio state that there has been an increase in the company's debt levels compared to the company's assets but the ratios are below any red flag levels.
As Barrick Gold's bond rating currently stands at "BBB+, "Adequate capacity to meet financial commitments, but more subject to adverse economic conditions." Barrick Gold has a rating that meets this description.
The CAPM approach for cost of equity states that shareholders need 4.23% average per year over a long period of time on their equity to make it worthwhile to invest in the company. This calculation is so based on the average market return between 1950 and 2012 at 7%.
The WACC calculation reveals that the company pays 4.82% on every dollar that it finances. As the current WACC of Barrick Gold is currently 4.82% and the beta is below average at 0.45, this implies that the company needs at least 4.82% on future investments and will have below average volatility moving forward.
The analysis of Barrick Gold's debt and liabilities indicates a company that has increased its liabilities over the past 3 years. The analysis also reveals that the company's assets growth rate has also increased over the past 3 years. The Bond rating of "BBB+" by Standard & Poor's indicates that the company has an "Adequate capacity to meet financial commitments, but more subject to adverse economic conditions." The WACC reveals that Barrick Gold has the ability to add future investments and assets at around 4.82%. Currently, Barrick Gold has the ability to pay for its debts, meet its obligations, while adding growth.
All indications above reveal a company that has significantly increased its debt over the past 3 years. The analysis also reveals that the company has not increased the debt and liabilities levels enough to create any "red flags." The Bond rating of "BBB+" indicates the company has an "Adequate capacity to meet financial commitments, but more subject to adverse economic conditions." The analysis indicates a slight increase in risk to the shareholder but the CAPM reveals that the investor needs 4.23% year-over-year over the long term to get good value on their money. In my opinion, 4.23% is a reasonable expectation for a return year-over-year over the long term.