Debt ratios help investors analyze a company's ability to pay the principal and interest on its outstanding debt. The ratios reveal how a company finances its asset purchases and its ability to withstand economic turbulence. They also indicate whether the company is using debt responsibly to grow its business or if it is relying excessively on debt to meet core obligations. The latter could imply there is trouble looming in the near future.
Certain debt ratios should be compared to benchmarks while others are more subjective and are better compared to the ratios of industry peers and the broader market. For a large-cap retailer such as Walmart Inc. (NYSE: WMT), the most reliable debt ratios to evaluate are the debt-to-equity ratio, interest coverage ratio, and cash flow-to-debt ratio.
- Investors use debt ratios to analyze how a company finances its asset purchases and the company's ability to pay its outstanding debt.
- Three debt ratios commonly used to evaluate a company are the debt-to-equity ratio, interest coverage ratio, and cash flow-to-debt ratio.
- A high debt-to-equity ratio indicates a company relies on debt as opposed to equity to finance its asset purchases.
- As of April 30, 2020, Walmart's debt-to-equity ratio was 0.85, a figure signaling the company was using more equity than debt to finance its asset purchases.
The debt-to-equity (D/E) ratio compares the percentage of a company's assets financed by debt to the percentage financed by equity. A high D/E ratio suggests a company is more leveraged and reliant on debt to finance asset purchases. While using leverage is not an inherently bad thing, using too much leverage can place a company in a precarious position.
Walmart's D/E ratio as of April 30, 2019, was 0.85. This is a healthy figure that has remained remarkably steady over the past decade. It indicates the company is using more equity than debt to finance asset purchases, and its debt management practices have not wavered even during an economically turbulent period.
Among its two primary competitors, Target had a higher D/E ratio at 1.46 as of May 2020, while Costco's D/E ratio is lower at 0.59 as of June 2020.
Interest Coverage Ratio
The interest coverage ratio measures how many times a company can pay the interest on its outstanding debt with its current earnings. A high ratio means a company is not likely to default on debt obligations in the near future. Most analysts agree the absolute lowest acceptable interest coverage ratio is 1.5, although value investors prefer companies with a significantly higher number.
Walmart's interest coverage ratio was 7.45 as of April 2020. With its current earnings, the company could pay the interest on its outstanding debt around 16 times over. Walmart Inc.'s interest coverage ratio improved from 2016 to 2017 but then deteriorated significantly from 2017 to 2020.
However, Costco had a much greater interest coverage ratio at 31.86 as of May 2020. Target had an interest coverage ratio of 4.00 as of April 2020, a sharp decline from previously.
Cash Flow-to-Debt Ratio
The cash flow-to-debt ratio measures the percentage of a company's total debt it can pay with its current cash flow. This is an effective metric to consider along with the interest coverage ratio because it includes only earnings that have actually materialized in cash.
Walmart's cash flow-to-debt ratio was 0.20 as April 2020, meaning its current cash flow could pay 20% of its debt. Many analysts consider a double-digit percentage to be a healthy sign, however, Walmart's cash flow-to-debt ratio only reached its current level in July 2018. It will be important to watch this trend in the future as an indicator of the company's commitment to responsible debt management.
Target had a cash flow-to-debt ratio of 0.28 as of April 2020, signalling that Target’s current level of operating cash is low, while Costco's is a much higher 1.01 as of May 2020.