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 a 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 The Boeing Company's (NYSE:BA) 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 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 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.
- 2007 - $7.455 billion + 762 million = $8.217 billion
- 2008 - $6.952 billion + $560 million = $7.512 billion
- 2009 - $12.217 billion + $707 million = $12.924 billion
- 2010 - $11.473 billion + $948 million = $12.421 billion
- 2011 - $10.018 billion + $2.353 billion = $12.371 billion
Boeing Company's total debt has increased over the past five years. The company reported a five-year low of $7.512 billion in 2008 and a five-year high in 2009 at $12.924 billion. The company's 2011 reported total debt of $12.371 billion is an increase of 50.55% over 2007.
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.
- 2007 - $49.982 billion
- 2008 - $55.073 billion
- 2009 - $59.925 billion
- 2010 - $65.799 billion
- 2011 - $76.471 billion
Boeing Company's liabilities have increased from $49.982 billion in 2007 to $76.471 billion in 2011, an increase of 52.99%.
In analyzing the company's total debt and liabilities, we can see that the company currently has a moderate amount of debt at $12.371 billion but a sizable amount of liabilities at $76.471 billion. Over the past five years, the total debt has increased by 50.55%, while total liabilities have increased by 52.99%. As the company's debt and liabilities have increased over the past 5 years, the next step will reveal if the company has the ability to pay for these debts.
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.
- 2009 - $12.924 billion / $62.053 billion = 0.21
- 2010 - $12.421 billion / $68.565 billion = 0.18
- 2011 - $12.371 billion / $79.986 billion = 0.15
As Boeing's total debt to total assets ratio is well below 1, this indicates that Boeing has many more assets than total debt, ensuring that the company is currently in good financial condition.
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.
- 2009 - $59.925 billion / $62.053 billion = 0.97
- 2010 - $65.799 billion / $68.565 billion = 0.96
- 2011 - $76.471 billion / $79.986 billion = 0.96
In looking at Boeing's total liabilities to total assets ratio, we can see that the ratio has remained very constant over the past three years. As these numbers are very close to 1, this indicates that Boeing has financed most of the company's assets through debt. As Boeing has a high debt ratio and is very close to 1, this implies that the company could be in danger of being "highly leveraged."
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 to 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.
- 2009 - $59.925 billion / $3.515 billion = 17.04
- 2010 - $65.799 billion / $2.766 billion = 23.79
- 2011 - $76.471 billion / $2.128 billion = 35.94
Boeing's 2011 debt to equity ratio has increased significantly compared to 2009. As the 2011 debt to equity ratio is high this indicates that suppliers, lenders, creditors and obligators have more equity invested than shareholders. This indicates a high amount of risk for the company. As the ratio is well above 1 and considered high, 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. 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.
- 2009 - $12.217 billion / $15.732 billion = 0.78
- 2010 - $11.473 billion / $14.239 billion = 0.81
- 2011 - $10.018 billion / $12.146 billion = 0.82
Over the past three years, Boeing's capitalization ratio has been increasing slightly. This implies that the company has had slightly less equity compared to its long-term debt. As this is the case, the company has had slightly less equity to support its operations and add growth through its equity. As the ratio has only slightly increased so has 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, the higher the ratio the better. When a company's interest coverage ratio is 1.5 or lower, its ability to meet interest expenses may be questionable.
- 2010 - $2.070 billion / $339 million = 6.11
- 2010 - $5.023 billion / $516 million = 9.73
- 2011 - $5.891 billion / $498 million = 11.83
As Boeing's interest coverage ratio has been increasing over the past 3 years and is high at 11.83, this implies that the company is not burdened by its debt 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.
- 2009 - $5.603 billion / $12.924 billion = 0.43
- 2010 - $2.952 billion / $12.421 billion = 0.24
- 2011 - $4.023 billion / $12.371 billion = 0.33
As the cash flow to debt ratio in the previous three years is below 100% or 1, this implies that the company has not had the ability to cover its total debt with its yearly cash flow from operations.
Based on the above six debt ratios, we can see some weaknesses in the amount of liabilities the company possesses. The main weakness that the analysis reveals is in the debt ratio. The debt ratio measures the total liabilities to the total assets and as the number is very close to 1 it implies that the company is getting close to being "highly leveraged." This is one area of the company to be aware of and watch moving forward. As the rest of the ratios look to be in good standing this indicates that Boeing 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 Boeing Company's bonds "A"
- Current 20 year corporate bond Rate of "A" = 4.07%
- Current cost of Debt as of August 27th 2012 = 4.07%
According to the S&P rating guide, the "A" rating is "strong capacity to meet financial commitments but somewhat susceptible to adverse economic conditions and changes in circumstances." Boeing has a rating that meets this description.
10. Current tax rate ( Income Tax total / Income before Tax)
- 2007 - $2.060 billion / $6.118 billion = 33.67%
- 2008 - $1.341 billion / $3.995 billion = 33.57%
- 2009 - $396 million / $1.731 billion = 22.87%
- 2010 - $1.196 million / $4.507 billion = 26.53%
- 2011 - $1.382 billion / $5.393 billion = 25.62%
Over the past five years, Boeing has averaged a tax rate of 28.45%.
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.
- .0407 x (1 - .2845) = Cost of debt after tax
The cost of debt after tax for Boeing is 2.91%
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 = US 10 year bond = 1.66% (Bloomberg)
- average market return 1950 - 2011 = 7%
- Beta = (Google Finance) Boeing beta = 1.23
Risk free rate + Beta equity (Average market return - Risk free rate)
- 1.66 + 1.23 (7-1.66)
- 1.66 + 1.23 x 5.34
- 1.66 + 6.56 = 8.22%
Boeing has a cost of equity or R Equity of 8.22%. So investors should expect to get a return of 8.22% 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 - 2011 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 = 28.45% (Boeing's five-year average Tax Rate)
Cost of Debt (before tax) or R debt = 4.07%
Cost of Equity or R equity = 8.22%
Debt (Total Liabilities) for 2011 or D = $76.471 billion
Stock Price = $71.44 (August 27, 2012)
Outstanding Shares = 874.80 Million
Equity = Stock price x Outstanding Shares or E = $ 62.495 billion
Debt + Equity or D+E = $138.996 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 - .2845) x .0407 x ($76.471/$138.996) + .0822 ($62.495/$138.996)
.7155 x .0407 x .5502 + .0822 x .4496
.0160 + .0369
Based on the calculations above, we can arrive that Boeing pays 5.29% on every dollar that it finances or .05.29 on every dollar. From this calculation we understand that on every dollar the company spends on an investment, the company must make $.05.29, plus the cost of the investment for the investment to be feasible for the company.
In analyzing the company's total debt and liabilities, we can see that the company currently has a moderate amount of debt at $12.371 billion and a very large amount of liabilities at $76.471 billion. Over the past five years, the total debt has increased by 50.55%, while the total liabilities have increased by 52.99%. As Boeing has a very sizeable amount of liabilities the next step should reveal if the company has the ability to meet those obligations.
Based on the above six debt ratios, we can see that Boeing has good results in five of the six rations. The ratio that raises a concern is the debt ratio. As the total liabilities to total assets is very near 1 this implies that the company could be in danger of being "highly leveraged." The debt ratio is one area of the company to watch moving forward. As the other 5 ratios reveal good results this indicates that Boeing has the ability to pay for its debt and is not on the verge of bankruptcy.
As Boeing's bond rating currently stands at "A" this indicates that the company has "strong capacity to meet financial commitments but somewhat susceptible to adverse economic conditions and changes in circumstances."
The CAPM approach for cost of equity states that shareholders need 3.10% 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 2011 at 7%.
The WACC calculation reveals that the company pays 5.29% on every dollar that it finances. As the current WACC of Boeing is currently 5.29% and the beta is low at 1.23, it implies that the company needs 5.29% on future investments and will have very low volatility moving forward.
Based on the calculations above, the company has a very sizable amount of liabilities in comparison to the size of the company but currently, has the capacity to make its debts payments, meet its tax obligations and is not in danger of bankruptcy.
The analysis of Boeing's debt and liabilities indicates a strong company with a very sizeable amount of liabilities and currently has the ability to pay for them. The analysis also reveals the company has some weakness in its debt ratio but also reveals that the company is quite strong in regards to the other five ratios. The WACC reveals that Boeing also and has the ability to add future investments and assets at very low rates. Currently, Boeing has the ability to pay for its debts, meet its tax obligations, is not in danger of bankruptcy and has the opportunity to capitalize on future investments with low risk.