Microsoft Corporation (NASDAQ:MSFT), a large-cap worth US$754b, comes to mind for investors seeking a strong and reliable stock investment. Market participants who are conscious of risk tend to search for large firms, attracted by the prospect of varied revenue sources and strong returns on capital. But, its financial health remains the key to continued success. Let’s take a look at Microsoft’s leverage and assess its financial strength to get an idea of their ability to fund strategic acquisitions and grow through cyclical pressures. Note that this information is centred entirely on financial health and is a high-level overview, so I encourage you to look further into MSFT here.
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How does MSFT’s operating cash flow stack up against its debt?
MSFT has shrunken its total debt levels in the last twelve months, from US$96b to US$88b – this includes long-term debt. With this debt repayment, MSFT’s cash and short-term investments stands at US$136b , ready to deploy into the business. Additionally, MSFT has produced US$45b in operating cash flow in the last twelve months, resulting in an operating cash to total debt ratio of 51%, indicating that MSFT’s debt is appropriately covered by operating cash. This ratio can also be a sign of operational efficiency as an alternative to return on assets. In MSFT’s case, it is able to generate 0.51x cash from its debt capital.
Can MSFT pay its short-term liabilities?
Looking at MSFT’s US$56b in current liabilities, the company has been able to meet these obligations given the level of current assets of US$164b, with a current ratio of 2.92x. Generally, for Software companies, this is a reasonable ratio since there is a bit of a cash buffer without leaving too much capital in a low-return environment.
Can MSFT service its debt comfortably?
With total debt exceeding equities, Microsoft is considered a highly levered company. This isn’t surprising for large-caps, as equity can often be more expensive to issue than debt, plus interest payments are tax deductible. Since large-caps are seen as safer than their smaller constituents, they tend to enjoy lower cost of capital. No matter how high the company’s debt, if it can easily cover the interest payments, it’s considered to be efficient with its use of excess leverage. Net interest should be covered by earnings before interest and tax (EBIT) by at least three times to be safe. For MSFT, the ratio of 119x suggests that interest is comfortably covered. High interest coverage serves as an indication of the safety of a company, which highlights why many large organisations like MSFT are considered a risk-averse investment.
Next Steps:
MSFT’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. Since there is also no concerns around MSFT’s liquidity needs, this may be its optimal capital structure for the time being. This is only a rough assessment of financial health, and I’m sure MSFT has company-specific issues impacting its capital structure decisions. I suggest you continue to research Microsoft to get a better picture of the large-cap by looking at:
- Future Outlook: What are well-informed industry analysts predicting for MSFT’s future growth? Take a look at our free research report of analyst consensus for MSFT’s outlook.
- Valuation: What is MSFT 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 MSFT is currently mispriced by the market.
- 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.
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