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 aiding in the 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 Schlumberger Limited's (SLB) 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
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 - $3.794 billion + $1.672 billion = $5.466 billion
- 2008 - $3.372 billion + $1.597 million = $4.969 billion
- 2009 - $4.355 billion + $1.125 billion = $5.480 billion
- 2010 - $5.517 billion + $2.595 million = $8.112 billion
- 2011 - $8.556 billion + $1.377 billion = $9.933 billion
Schlumberger's total debt has been increasing over the past five years. In 2007, Total reported a total debt of $5.466 billion. In 2011, the company reported a total debt of $9.933 billion. Over the past 5 years Schlumberger's total debt has increased by 81.72%.
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 - $12.977 billion
- 2008 - $15.128 billion
- 2009 - $14.345 billion
- 2010 - $20.541 billion
- 2011 - $23.938 billion
Schlumberger's liabilities have increased significantly over the past 5 years. In 2007, the company reported liabilities at $12.977 billion; in 2011, the company reported liabilites at $23.938 billion. This is an increase of 84.46% .
In analyzing Schlumberger's total debt and liabilities, we can see that the company currently has debt at $9.933 billion and liabilities at $23.938 billion. Over the past five years, the total debt has increased by 81.72%, while total liabilities have increased by 84.46%. As the company's amount of debt and amount of liabilities have increased significantly over the past 5 years, the next step will reveal if the company has the ability to pay for their 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.
- 2009 - $5.480 billion / $33.465 billion = 0.16
- 2010 - $8.112 billion / $51.767 billion = 0.16
- 2011 - $9.933 billion / $55.201 billion = 0.18
As Schlumberger's total-debt-to-total-assets ratio has been relatively the same and is below 1, this states that Schlumberger Limited's total debt and assets have been increasing at the same rate. As the number is currently below 1, this states that the risk to the company regarding its debt to assets has been relatively the same over the past three years.
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.
- 2009 - $14.345 billion / $33.465 billion = 0.43
- 2010 - $20.541 billion / $51.767 billion = 0.40
- 2011 - $23.938 billion / $55.201 billion = 0.43
In looking at Schlumberger Limited's total liabilities to total assets ratio, we can see that the ratio has remained relatively the same over the past three years. As these numbers are below the 0.50 mark, this indicates that Schlumberger Limited has not financed most of the company's assets through debt but though its equity. This indicates a good level of financial health for 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.
- 2009 - $14.345 billion / $19.120 billion = 0.75
- 2010 - $20.541 billion / $31.226 billion = 0.66
- 2011 - $23.938 billion / $31.263 billion = 0.77
Over the past three years, Schlumberger's debt-to-equity ratio has bounced around from a low of 0.66 to a high of 0.77. As the ratio is below 1, this indicates that shareholders have more equity invested than suppliers, lenders, creditors and obligators. 0.77 indicates a moderately low amount of risk for the company. As the ratio is below 1 and considered moderately low, 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.
- 2009 - $4.355 billion / $23.455 billion = 0.19
- 2010 - $5.517 billion / $36.743 billion = 0.15
- 2011 - $8.556 billion / $39.819 billion = 0.21
Over the past three years, Schlumberger's capitalization ratio has increased from 0.19 to 0.21. This implies that the company has had slightly 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 still very low this implies a low amount 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.
- 2009 - $5.266 billion / $5.480 billion = 0.96
- 2010 - $5.494 billion / $8.112 billion = 0.68
- 2011 - $6.169 billion / $9.933 billion = 0.62
Over the past three years, the cash flow to total debt ratio has been decreasing. The ratio has dropped from 0.96 to 0.62. 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 Schlumberger Limitied's ratios have remained strong over the past 3 years. Even though the debt and liabilities have increased the ratios indicate that the company's growth has kept up with the increase in debt and liabilities. As this is the case, the ratios indicate approximately the same amount of risk to the company as 3 years ago. 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 Schlumberger Limited's bonds "A+"
- Current 20-year corporate bond Rate of "A" = 3.92%
- Current cost of Debt as of October 11th 2012 = 3.92%
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." Schlumberger Limited has a rating that meets this description.
9. Current tax rate ( Income Tax total / Income before Tax)
- 2007 - $1.448 billion / $6.624 billion = 21.86%
- 2008 - $1.430 billion / $6.852 billion = 20.87%
- 2009 - $770 million / $3.934 billion = 19.57%
- 2010 - $890 million / $5.156 billion = 17.26%
- 2011 - $1.545 billion / $6.338 billion = 24.38%
5-year average = 20.79%
Over the past five years, Schlumberger Limited has averaged a tax rate of 20.79%.
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.
- .0392 x (1 - .2079) = Cost of debt after tax
The cost of debt after tax for Schlumberger Limited is 3.11%
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 = 1.72% (Bloomberg)
- Average market return 1950 - 2011 = 7%
- Beta = (Google Finance) Schlumberger Limited's beta = 1.39
Risk free rate + Beta equity (Average market return - Risk free rate)
- 1.72 + 1.39 (7-1.72)
- 1.72 + 1.39 x 5.28
- 1.72 + 6.67 = 8.39%
Schlumberger Limited's has a cost of equity or R Equity of 8.39%, so investors should expect to get a return of 8.39% 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 - 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 = 20.79% (Schlumberger Limited's five-year average Tax Rate)
Cost of Debt (before tax) or R debt = 3.92%
Cost of Equity or R equity = 8.39%
Debt (Total Liabilities) for 2011 or D = $23.938 billion
Stock Price = $71.08 (October 11th, 2012)
Outstanding Shares = 1.33 billion
Equity = Stock price x Outstanding Shares or E = $94.536 billion
Debt + Equity or D+E = $118.474 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 - .2079) x .0392 x ($23.938/$118.474) + .0839 ($94.536/$118.474)
.7921 x .0392 x .2021 + .0839 x .7979
.0063 + .0669
Based on the calculations above, we can conclude that Schlumberger Limited pays 7.32% on every dollar that it finances, or 7.32 cents on every dollar. From this calculation, we understand that on every dollar the company spends on an investment, the company must make $.0732 plus the cost of the investment for the investment to be feasible for the company.
In analyzing Schlumberger's total debt and liabilities, we can see that the company currently has debt at $9.933 billion and liabilities at $23.938 billion. Over the past five years, the total debt has increased by 81.72%, while total liabilities have increased by 84.46%. The company's amount of debt and amount of liabilities have increased significantly over the past 5 years.
Based on the five debt ratios listed above, we can see that Schlumberger Limitied's ratios have remained strong over the past 3 years. Even though the debt and liabilities have increased, the ratios indicate that the company's growth has kept up with the increase in debt and liabilities. As this is the case, the ratios indicate approximately the same amount of risk to the company as 3 years ago.
As Schlumberger Limited's bond rating currently stands at "A+" this indicates that the company has a "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 8.39% 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 2011 at 7%.
The WACC calculation reveals that the company pays 7.32% on every dollar that it finances. As the current WACC of Schlumberger Limited is currently 7.32% and the beta is above average at 1.39, this implies that the company needs at least 7.32% on future investments and will have above average volatility moving forward.
Based on the calculations above, the company has increased its debt and liabilities but currently has the capacity to make its debt payments and meet its tax obligations.
The analysis of Schlumberger Limited's debt and liabilities indicates a very strong company with increasing debt and liabilities. The analysis also reveals that the company growth rate is keeping up with the debt and liabilities enabling it to keep the risk to the shareholder approximately the same. The Bond rating of "A+" by S&P indicates that a company has a "Strong capacity to meet financial commitments but somewhat susceptible to adverse economic conditions and changes in circumstances." The WACC reveals that Schlumberger Limited has the ability to add future investments and assets at relatively low rates. Currently, Schlumberger Limited has the ability to pay for its debts meet its obligations while adding growth.
All indications above reveal a company with strong investment potential over the long term for the shareholder as long as the above ratios maintain or improve on their current standards.
For another article on Schlumberger Limited please read:
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.