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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 Weatherford International Limited's (NYSE:WFT) 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 such as Schlumberger (NYSE:SLB), Halliburton (NYSE:HAL) and you will be able see which company has the most debt, thus adding to the company's risk.

All material is sourced from Google Finance, Morningstar and the company webpage.

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 - $3.066 billion + $774 million = $3.810 billion
  • 2008 - $4.564 billion + $1.256 billion = $5.820 billion
  • 2009 - $5.847 billion + $870 million = $6.717 billion
  • 2010 - $6.530 billion + $235 million = $6.765 billion
  • 2011 - $6.286 billion + $1.320 billion = $7.606 billion

Weatherford's total debt has been increasing over the past five years. In 2007, Total reported a total debt of $3.810 billion. In 2011, the company reported a total debt of $7.606 billion. Over the past 5 years Weatherford's total debt has increased by 99.63%.

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 - $5.784 billion
  • 2008 - $8.191 billion
  • 2009 - $9.147 billion
  • 2010 - $9.731 billion
  • 2011 - $11.653 billion

Weatherford's liabilities have increased significantly over the past 5 years. In 2007, the company reported liabilities at $5.784 billion; in 2011, the company reported liabilities at $11.653 billion. This is an increase of 101.46% .

In analyzing Weatherford's total debt and liabilities, we can see that the company currently has a total debt of $7.606 billion and liabilities at $11.653 billion. Over the past five years, the total debt has increased by 99.63%, while total liabilities have increased by 101.46%. 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.

Debt Ratios

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 - $6.717 billion / $18.770 billion = 0.36
  • 2010 - $6.765 billion / $19.207 billion = 0.35
  • 2011 - $7.606 billion / $21.185 billion = 0.36

As Weatherford's total-debt-to-total-assets ratio has been relatively the same and is below 1, this states that Weatherford International'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 - $9.147 billion / $18.770 billion = 0.49
  • 2010 - $9.731 billion / $19.207 billion = 0.51
  • 2011 - $11.653 billion / $21.185 billion = 0.55

In looking at Weatherford's total liabilities to total assets ratio, we can see that this ratio has been increasing over the past 3 years. As these numbers are above the 0.50 mark, this indicates that Weatherford has financed most of the company's assets through debt thus adding to the risk of the company. 0.55 indicates a moderate amount of risk 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 - $9.147 billion / $9.720 billion = 0.94
  • 2010 - $9.731 billion / $9.401 billion = 1.04
  • 2011 - $11.653 billion / $9.532 billion = 1.22

Over the past three years, Weatherford's debt-to-equity ratio has increased from a low of 0.94 to a high of 1.22. As the most current ratio is above 1, this indicates that suppliers, lenders, creditors and obligators have more invested than shareholders. 1.22 indicates a moderately amount of risk for the company. As the ratio is above 1 and 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.

  • 2009 - $6.717 billion / $16.437 billion = 0.41
  • 2010 - $6.765 billion / $16.166 billion = 0.42
  • 2011 - $7.606 billion / $17.138 billion = 0.44

Over the past three years, Weatherford's capitalization ratio has increased from 0.41 to 0.44. 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 quite low this implies a lower amount of risk to the company.

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 - $666 billion / $299 million = 2.22
  • 2010 - $611 million / $406 million = 1.50
  • 2011 - $1.217 billion / $453 million = 2.69

Weatherford's interest coverage ratio has been bouncing around over the past 3 years. As the current interest ratio is over 1.5 this implies that the company is not burdened by debt expenses, but this is one area to watch regarding the company. In 2010 the interest ratio was at 1.5. If the ratio continued to keep falling, this could have made it's ability to meet its interest payments "questionable".

8. 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 - $614 million / $6.717 billion = 0.09
  • 2010 - $1.128 billion / $6.765 billion = 0.17
  • 2011 - $833 million / $7.606 billion = 0.11

Over the past three years, the cash flow to total debt ratio has been under 0.2. 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 six debt ratios listed above, we can see that Weatherford International's ratios have been slightly decreasing over the past 3 years. The interest coverage ratio is the ratio to watch moving forward. Even though the interest coverage ratio rebounded in 2011, it did get to 1.5 in 2010.

Over the past 3 years the debt and liabilities have been increasing and as the ratios indicate, the company's equity and assets have not kept up. This indicates that over the past 3 years the company's growth has been slightly less than the increase in debt and liabilities. As this is the case, the ratios indicate slightly more 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.

According to the S&P rating guide, the "BBB" rating is - "Adequate capacity to meet financial commitments, but more subject to adverse economic conditions." Weatherford International has a rating that meets this description.

9. Current tax rate ( Income Tax total / Income before Tax)

  • 2007 - $333 billion / $1.444 billion = 23.06%
  • 2008 - $289 billion / $1.690 billion = 17.10%
  • 2009 - $20 million / $299 billion = 6.68%
  • 2010 - $298 million / $205 billion = 145%
  • 2011 - $486 billion / $764 billion = 63.61%

5-year average subtracting 2010 = 27.61%

Over the past five years, Weatherford has averaged a tax rate of 27.61%.

Over the past few years there have been some reported issues regarding Weatherford's taxes.

Weatherford International Downgraded to "Nuetral" on Tax Issues

Weatherford International Management Discusses Q2 2012 Results

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 - .2761) = Cost of debt after tax

The cost of debt after tax for Weatherford International is 4.84%

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 = 1.76% (Bloomberg)
  • Average market return 1950 - 2011 = 7%
  • Beta = (Google Finance) Weatherford International's beta = 1.77

Risk free rate + Beta equity (Average market return - Risk free rate)

  • 1.76 + 1.77 (7-1.76)
  • 1.76 + 1.77 x 5.24
  • 1.76 + 7.01 = 8.77%

Weatherford's has a cost of equity or R Equity of 8.77%, so investors should expect to get a return of 8.77% 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 = 27.61% (Weatherford International's five-year average Tax Rate)

Cost of Debt (before tax) or R debt = 4.84%

Cost of Equity or R equity = 8.77%

Debt (Total Liabilities) for 2011 or D = $11.653 billion

Stock Price = $12.20 (October 21th, 2012)

Outstanding Shares = 759.57 million

Equity = Stock price x Outstanding Shares or E = $9.266 billion

Debt + Equity or D+E = $20.919 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 - .2761) x .0669 x ($11.653/$20.919) + .0877 ($9.266/$20.919)

.7239 x .0669 x .5571 + .0877 x .4429

.0270 + .0388

= 6.58%

Based on the calculations above, we can conclude that Weatherford pays 6.58% on every dollar that it finances, or 6.58 cents on every dollar. From this calculation, we understand that on every dollar the company spends on an investment, the company must make $.0658 plus the cost of the investment for the investment to be feasible for the company.

Summary

In analyzing Weatherford's total debt and liabilities, we can see that the company currently has a total debt of $7.606 billion and liabilities at $11.653 billion. Over the past five years, the total debt has increased by 99.63%, while total liabilities have increased by 101.46%.

Based on the six debt ratios listed above, we can see that Weatherford International's ratios have been slightly decreasing over the past 3 years. The interest coverage ratio is the ratio to watch moving forward. Even though the interest coverage ratio rebounded in 2011, it did get to 1.5 in 2010.

Over the past 3 years the debt and liabilities have been increasing and as the ratios indicate, the company's equity and assets have not kept up. This indicates that over the past 3 years the company's growth has been slightly less than the increase in liabilities. As this is the case, the ratios indicate slightly more risk to the company as 3 years ago.

As Weatherford's bond rating currently stands at "BBB" this indicates that the company has a "Adequate capacity to meet financial commitments, but more subject to adverse economic conditions."

The CAPM approach for cost of equity states that shareholders need 8.77% 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 6.58% on every dollar that it finances. As the current WACC of Weatherford Internationa is currently 6.58% and the beta is above average at 1.77, this implies that the company needs at least 6.58% 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 Weatherford's debt and liabilities indicates a company with increasing debt and liabilities. The analysis also reveals that the company's equity and assets are slowly falling behind the liabilities. The Bond rating of "BBB" by S&P indicates that a company has a "Adequate capacity to meet financial commitments, but more subject to adverse economic conditions." The WACC reveals that Weatherford has the ability to add future investments and assets at relatively low rates. Currently, Weatherford International has the ability to pay for its debts and meet its obligations.

Indications above reveal a company who's equity and assets are slowly falling behind its liabilities and is dealing with tax issues. An improvement in these aspects of the company would be beneficial for the investor moving forward.

Source: Analyzing Weatherford International's Debt And Risk