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Fortescue Metals Group Limited (ASX:FMG): Time For A Financial Health Check

Stocks with market capitalization between $2B and $10B, such as Fortescue Metals Group Limited (ASX:FMG) with a size of AU$12.1b, do not attract as much attention from the investing community as do the small-caps and large-caps. Despite this, the two other categories have lagged behind the risk-adjusted returns of commonly ignored mid-cap stocks. Let’s take a look at FMG’s debt concentration and assess their financial liquidity to get an idea of their ability to fund strategic acquisitions and grow through cyclical pressures. Don’t forget that this is a general and concentrated examination of Fortescue Metals Group’s financial health, so you should conduct further analysis into FMG here.

View our latest analysis for Fortescue Metals Group

How does FMG’s operating cash flow stack up against its debt?

Over the past year, FMG has reduced its debt from US$4.5b to US$4.0b – this includes both the current and long-term debt. With this debt repayment, FMG currently has US$863m remaining in cash and short-term investments , ready to deploy into the business. On top of this, FMG has generated US$1.6b in operating cash flow in the last twelve months, leading to an operating cash to total debt ratio of 40%, meaning that FMG’s current level of operating cash is high enough to cover debt. This ratio can also be interpreted as a measure of efficiency as an alternative to return on assets. In FMG’s case, it is able to generate 0.4x cash from its debt capital.

Does FMG’s liquid assets cover its short-term commitments?

With current liabilities at US$1.2b, it seems that the business has been able to meet these commitments with a current assets level of US$1.7b, leading to a 1.33x current account ratio. For Metals and Mining companies, this ratio is within a sensible range since there’s a sufficient cash cushion without leaving too much capital idle or in low-earning investments.

ASX:FMG Historical Debt October 21st 18
ASX:FMG Historical Debt October 21st 18

Does FMG face the risk of succumbing to its debt-load?

FMG is a relatively highly levered company with a debt-to-equity of 41%. This is not unusual for mid-caps as debt tends to be a cheaper and faster source of funding for some businesses. We can check to see whether FMG is able to meet its debt obligations by looking at the net interest coverage ratio. A company generating earnings before interest and tax (EBIT) at least three times its net interest payments is considered financially sound. In FMG’s, case, the ratio of 5.83x suggests that interest is appropriately covered, which means that lenders may be inclined to lend more money to the company, as it is seen as safe in terms of payback.

Next Steps:

FMG’s high cash coverage means that, although its debt levels are high, the company is able to utilise its borrowings efficiently in order to generate cash flow. This may mean this is an optimal capital structure for the business, given that it is also meeting its short-term commitment. I admit this is a fairly basic analysis for FMG’s financial health. Other important fundamentals need to be considered alongside. I suggest you continue to research Fortescue Metals Group to get a more holistic view of the mid-cap by looking at:

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  1. Future Outlook: What are well-informed industry analysts predicting for FMG’s future growth? Take a look at our free research report of analyst consensus for FMG’s outlook.

  2. Valuation: What is FMG worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether FMG is currently mispriced by the market.

  3. Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.