Over the past few weeks I have been watching the recent developments of the apparel stores industry. This has provided an excellent opportunity to search for stocks in this sector for investment purposes. One company I think is very interesting to analyze is Limited Brands, Inc. (LTD). While there are many different factors to look at and consider when investing, in the article below I will look at the debt side of the company. I will analyze Limited Brands, Inc.'s total debt, total liabilities, debt ratios and what analyst and other top investors believe about this company. From this analysis we should get an idea if the company is highly leveraged and how much to expect in return for investing in this company over the long term.
It is essential to remark that gaining knowledge about Limited Brands debt and liabilities is a key component in understanding the risk of investing in this company. In 2008 and 2009 we were able to see some of the repercussions that highly leveraged companies with large amounts of debt succumbed to. By studying the debt part of Limited Brands, Inc., the investor can understand if the Limited is able to keep its capital and use it for growth in the future.
Total Debt to Total Assets Ratio
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.
Limited Brands, Inc.'s total debt to total assets ratio has increased over the past three years from 0.39 to 0.74. As the total debt to total assets ratio has increased, this indicates that since 2010, LTD has added more total debt value than total asset. This is not a good signal for bond investors.
As the number is currently well below 1, this indicates that L Brands, Inc. has more assets than total debt. Because this number is extremely low (0.74), this metric indicates very low financial risk to the company.
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.
In looking at Limited Brands, Inc.'s total liabilities to total assets ratio over the past three years, we can see that this ratio has also increased from 0.77 to 1.17. I do not like the fact that Limited increased the debt side of its balance sheet.
As the 2012 TTM numbers are above the 0.50 mark, this indicates that Limited Brands, Inc. has financed most of the company's assets through debt. As the number has increased, so is the risk to the company.
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.
Compared with 2010, Limited Brands, Inc.'s debt-to-equity ratio has increased. The ratio has increased from 3.37 in 2010 to 6.93 in 2012. I prefer companies that have a very low or minimal debt-to-equity ratio. It is basically a signal of a conservative balance sheet.
As the ratio is currently well above 1, this indicates that shareholders have invested more than suppliers, lenders, creditors and obligators. 6.93 indicates a high amount of risk for the company. As the ratio is above 1 and considered high, so is the risk for the company.
Capitalization Ratio = LT Debt / LT Debt + Shareholders' Equity
(LT Debt = Long-Term Debt)
The capitalization ratio tells the investors the extent to which the company is using its equity to support 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.
Over the past three years, Limited's capitalization ratio has increased from 0.63 in 2010 to 0.82 in 2012. This implies that the company has less equity compared with its long-term debt. As this is the case, the company has had more 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. As the ratio is 0.82 this implies moderate financial risk.
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.
Over the past three years, the cash flow to total debt ratio has decreased. The ratio has decreased from 0.51 in 2010 to 0.30 in 2012 TTM. I prefer companies that improve its Operating CF/Total Debt ratios.
As the ratio is below 1, this implies that the company does not has the ability to cover its total debt with its yearly cash flow from operations. The ideal is finding stocks that have ratios well above 1.
Institutional activity in Limited
I also evaluate recent institutional activity in the stock. In other words, I want to know which hedge funds bought the stock in the recent quarters.
Prominent investors Manning & Napier Advisors, Inc and PRIMECAP Management bought the stock in the past quarter at an average price of $49.9. As detailed in my blog, I like to see what hedge funds buy or sell in recent quarters.
Currently, many analysts have a good outlook for Limited Brands. Over the next few years analysts at MSN money are predicting LTD to have an EPS of $N/A for FY 2013 and an EPS of $3.14 for FY 2014. Analysts at Bloomberg are estimating Limited's revenue to be at $12B million for FY 2013 and $10.91B million for FY 2014. In 2012-07-17, Robert W. Baird gave L Brands, Inc. a rating of "Outperform" with a target price of $64. A $64 price target signifies significant upside potential from this point.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in LTD over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.