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.
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 Jan. 31, 2018, was 0.60. This is a healthy figure that has remained remarkably steady over the past decade. It indicates the company is using almost twice as much equity as 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 as of July 2018 while Costco's D/E ratio is slightly lower at 0.51 as of Aug. 2018.
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 10.38 as of July 2018. With its current earnings, the company could pay the interest on its outstanding debt almost 10 times over. Walmart Inc.'s interest coverage ratio improved from 2016 to 2017 but then deteriorated significantly from 2017 to 2018. However, Costco had a much greater interest coverage ratio at 30.13 as of Aug. 2018. Target had an interest coverage ratio of 9.85 as of July 2018.
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 for the quarter that ended in July 2018 was 0.20 as of Oct. 2018, meaning its current cash flow could pay 20% of its debt. Many analysts consider a double-digit percentage to be a healthy sign, and this ratio is further proof of Walmart's responsible debt management. Target also has a cash flow-to-debt ratio of 42.6% as of Jan. 2018, signaling that Target’s current level of operating cash is high enough to cover debt while Costco's is a lower 1.12 as of Aug. 2018. Walmart's cash flow-to-debt ratio has inched upward over the past decade, a trend that should give investors confidence in the company's continued financial health.