Large-cap companies such as Valero Energy Corporation (NYSE:VLO), with a market-capitalization of $30.56B, are much sought after by risk-averse investors who find diversified revenue streams and strong capital returns more comforting than explosive growth potential. But another key factor to consider when investing in VLO is its financial health. Why is it important? A major downturn in the energy industry has resulted in over 150 companies going bankrupt and has put more than 100 on the verge of a collapse, primarily due to excessive debt. Thus, it becomes utmost important for an investor to test a company’s resilience for such contingencies. In simple terms, I believe these three small calculations tell most of the story you need to know. Check out our latest analysis for Valero Energy
Is VLO’s level of debt at an acceptable level?
What is considered a high debt-to-equity ratio differs depending on the industry, because some industries tend to utilize more debt financing than others. A ratio below 40% for large-cap stocks is considered as financially healthy, as a rule of thumb. For VLO, the debt-to-equity ratio is 40.87%, which indicates that its debt can cause trouble for the company in a downturn but it is still at a manageable level. We can test if VLO’s debt levels are sustainable by measuring interest payments against earnings of a company. Ideally, earnings should cover interest by at least three times, therefore reducing concerns when profit is highly volatile. VLO’s interest on debt is sufficiently covered by earnings as it sits at around 6.25x. This means lenders may be inclined to lend more money to the company, as it is seen as safe in terms of payback.
How does VLO’s operating cash flow stack up against its debt?
A simple way to determine whether the company has put debt into good use is to look at its operating cash flow against its debt obligation. This also assesses VLO’s debt repayment capacity, which is not a big concern for a large company. In the case of VLO, operating cash flow turned out to be 0.55x its debt level over the past twelve months. A ratio of over 0.5x is a positive sign and shows that VLO is generating more than enough cash from its core business, which should increase its potential to pay back near-term debt.
Although VLO’s debt level is towards the higher end of the spectrum, its cash flow coverage seems adequate to meet obligations which means its debt is being efficiently utilised. This is nothing less than what we would expect from such a large company such as Valero Energy. Investors tend to gravitate towards these stocks purely for their stability and liquidity. Though, there are other factors we should also consider before buying VLO, such as its valuation. Now that you know to keep debt in mind when putting together your investment thesis, I recommend you check out our latest free analysis report on Valero Energy to see what other factors for VLO you should consider.
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