A company's debt, liabilities and risk are very important factors in understanding the company. Having an understanding of a company's debt and liabilities is key component in understanding the risk of a company, thus helping aid in a decision to invest, not to invest or to stay invested in a company. There are many metrics involved in understanding the debt of a company, but for this article, I will look at Joy Global's (NYSE:JOY) total debt, total liabilities, debt ratios and WACC.
Through the above-mentioned four main metrics, we will understand more about the company's debt, liabilities and risk. If this summary is compared with other companies in the same sector, you will be able see which who has the most debt and the most risk.
1. Total Debt = Long Term Debt + Short Term Debt
A debt is an amount of money borrowed by one party from another, and must be paid back. Total debt is the addition 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. The combination of the two is total debt.
- 2007 - $396.26 million + $0.24 million = $396.50 million
- 2008 - $540.97 million + $26.46 million = $567.43 million
- 2009 - $523.89 million + $19.79 million = $543.68 million
- 2010 - $396.33 million + $1.55 million = $397.88 million
- 2011 - $1.356,41 billion + $35.9 million = $1.392,31 billion
Joy Global's total debt the amount has increased from 396.50 million in 2007 to $1.392,31 billion in 2011 or by 351%.
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 are the addition of long-term liabilities, which are the liabilities that are due in one year or more, and short-term, or current liabilities, are any liabilities due within one year. The combination of the two equalstotal liabilities.
- 2007 - $1.410 billion
- 2008 - $2.111 billion
- 2009 - $2.194 billion
- 2010 - $1.928 billion
- 2011 - $3.474 billion
Joy Global's liabilities have increased from $1.410 billion in 2007 to $3.474 billion in 2011, or by 246%.
In analyzing the company's total debt and liabilities, we have seen a significant increase over the past 5 years. This is not necessarily bad, as much of this debt was incurred by the purchase of assets. The next step will reveal if the company has the ability to pay for these assets.
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 - $397.88 million / $3.271 billion = 0.12
- 2011 - $1.392,31 billion / $5.426 billion = 0.26
As Joy Global's total debt to total assets ratio is well below 1, this indicates that Joy Global has many more assets than total debt, ensuring that the company is not on the verge of bankruptcy.
4. Debt ratio = Total Liabilities / Total Assets
Total liabilities divided by total assets. The debt ratio shows the proportion of a company's assets which are 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 - $1.928 billion / $3.271 billion = 0.59
- 2011 - $3.474 billion / $5.426 billion = 0.64
As the total liabilities to total assets ratio has increased compared to 2010, it indicates that the company's total liabilities in relation total assets have increased. As the ratio is over 0.50 in both years, this indicates that Joy Global has financed most of the company's assets through debt, but as the ratio is below 1, currently the company is not in danger becoming insolvent and/or going bankrupt.
5. Debt to Equity Ratio = Total Liabilities / Shareholder's Equity
The debt to equity ratio is another leverage ratio that compares a company's total liabilities to its total shareholder's 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 - $1.928 billion / $1.343 billion = 1.44
- 2011 - $3.474 billion / $1.952 billion = 1.78
Even though Joy Global's 2011 debt to equity is quite high at 1.78, it is still below the industry average of 2.03. This indicates that suppliers, lenders, creditors and obligators have more equity invested than shareholders.
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. The 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 - $396 million / $1.739 billion = 22.77%
- 2011 - $1.356 billion / $3.308 billion = 40.99%
As Joy Global's long-term debt increased, so did the company's capitalization ratio. This implies that the company has less equity compared to its long-term debt. As this is the case, the company had less equity to support its operations and add growth through its equity, thus adding to the company's risk.
7. Interest Coverage Ratio = EBIT (Earnings before interest and taxes) / Interest Expenses
The interest coverage ratio is used to determine how easily a company can pay interest expenses on outstanding debt. The ratio is calculated by dividing a company's earnings before interest and taxes (EBIT) by the company's interest expenses for the same period. The lower the ratio, the more the company is burdened by debt expense. When a company's interest coverage ratio is only 1.5 or lower, its ability to meet interest expenses may be questionable.
- 2010 - $710.29 million / $29.964 million = 23.70
- 2011 - $934.05 million / $38.180 million = 24.46
As the company's Interest Coverage Ratio is very high, Joy Global is not burdened by debt expense. Joy Global has the ability to meet its interest expenses.
8. Cash Flow to Total Debt Ratio = Operating Cash Flow / Total Debt
This coverage ratio compares a company's operating cash flow to 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 - $583.49 million / $397.88 million = 146.67%
- 2011 - $504.69 million / $1.392.31 billion = 36.24%
In 2010, Joy Global had an excellent Cash Flow to Total Debt ratio, but in 2011, the ratio fell substantially. As the 2011 ratio was below 100%, it implies that the company did not have the ability to cover its total debt with its yearly cash flow from operations.
Based on the above 6 debt ratios, we can see that Joy Global has purchased many of its assets through debt. All indications above reveal that Joy Global has the ability to pay for its debt, and is not on the verge of bankruptcy. 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 to others. The higher the cost of debt the higher the risk.
9. Cost of debt (before tax) = Corporate Bond rate of company's bond rating.
- S&P rated Joy Global bonds "BBB"
- Current 20 year corporate bond Rate of "BBB" = 6.69%
- Current cost of Debt = 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." Joy Global has a rating that meets this description.
10. Current tax rate ( Income Tax total / Income before Tax)
- 2007 - 169.28 million / 449.06 million = 37.69%
- 2008 - 153.95 million / 527.09 million = 29.20%
- 2009 - 227.99 million / 682.64 million = 33.39%
- 2010 - 217.53 million / 679.02 million = 32.03%
- 2011 - 264.83 million / 895.83 million = 29.56%
5 year average = 32.37%
Over the past 5 years Joy Global has averaged a tax rate of 32.37%.
11. 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 - .3237) = Cost of debt after tax
The cost of debt after tax for Joy Global Inc is 4.52%
Cost of equity or R equity = (Risk free rate + Beta equity) x ( Average market return - Risk free rate) = R equity
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 = US 10 year bond = 1.55% (Bloomberg)
- average market return 1950 - 2011 = 7%
- Beta = (Google finance) Joy Global's beta = 2.15
(Risk free rate + Beta) x ( average market return - Risk free rate) = R equity
- (.0155 + 2.15) x (.07 - .0155) = 2.1655 x .0545= 11.80%
Joy Global has a Cost of Equity or R Equity of 11.80%. So investors would expect to get a 11.80% return on their investment to compensate for the risk they undertake by investing in this company.
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 = 32.37% (Joy Global 5 year average Tax Rate)
Cost of Debt (before tax) or R debt = 6.69%
Cost of Equity or R equity = 11.80%
Debt (Total Liabilities) for 2011 or D = $3.474 billion
Stock Price = $57.13 (July 6th 2012)
Outstanding Shares = 105.84 Million
Equity = Stock price x Outstanding Shares or E = $6.046 Billion
Debt + Equity or D+E = $9.52 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 - .3237) x .0669 x ($3.474/$9.52) + .118 ($6.046/$9.52)
.6763 x .0669 x .3649 + .118 x .6350
.0165 + .0749
Based on the calculations above we can arrive that Joy Global pays 9.14% on every dollar that it finances or $.0914 on every dollar.
In analyzing the company's total debt and liabilities over the past 5 years, we have seen a significant increase in these areas of the company. This is not necessarily a bad thing, as much of this debt was incurred by the purchase of assets, but It could be a bad thing if the company does not have the ability to pay for these debts and liabilities.
As illustrated above, we can see that Joy Global has purchased many of its assets through debt. All indications above reveal that Joy Global has the ability to pay for its debt and is not on the verge of bankruptcy.
As Joy Global's bond rating received a "BBB" rating, this indicates that the company has the ability to meet its obligations, but will be adversely effected by economic conditions.
As Joy Global has some risk to the stock, the Cost of Equity states that shareholders need 11.80% on their equity to make it worthwhile to invest in the company.
The WACC reveals that the company pays 9.14% on every dollar that it finances. As this number increases, so does the risk that is implied in the price.
Overall, the company will have some volatility, but currently, will be able to pay off its debts, meet its tax obligations and is not in danger of bankruptcy.
To read more fundamental analysis on Joy Global please read my articles:
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.