There are a number of reasons that attract investors towards large-cap companies such as Monsanto Company (NYSE:MON), with a market cap of USD $52.77B. One such reason is its ‘too big to fail’ aura which gives it the appearance of a strong and healthy investment. However, investors may not be aware of the metrics used to measure 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. See our latest analysis for MON

Is MON’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 MON, the debt-to-equity ratio stands at above 100%, which indicates that the company is holding a high level of debt relative to its net worth. In the event of financial turmoil, the company may experience difficulty meeting interest and other debt obligations. While debt-to-equity ratio has several factors at play, an easier way to check whether MON’s leverage is at a sustainable level is to check its ability to service the debt. A company generating earnings at least three times its interest payments is considered financially sound. MON’s interest on debt is sufficiently covered by earnings as it sits at around 9.09x. Debtors may be willing to loan the company more money, giving MON ample headroom to grow its debt facilities.

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

A basic way to evaluate MON’s debt management is to see whether the cash flow generated from the business is at a relatively high level compared to the debt capital invested. This also assesses MON’s debt repayment capacity, which is not a big concern for a large company. Last year, MON’s operating cash flow was 0.4x its current debt. This is a good sign, as over a quarter of MON’s near term debt can be covered by its day-to-day cash income, which reduces its riskiness to its debtholders.

Next Steps:

Are you a shareholder? MON’s high debt level shouldn’t be an impetus for investors to sell given its high operating cash flow seems adequate to meet obligations which means its debt is being put to good use. Since MON’s financial position could change, I suggest assessing market expectations for MON’s future growth on our free analysis platform.

Are you a potential investor? Although understanding the serviceability of debt is important when evaluating which companies are viable investments, it shouldn’t be the deciding factor. Ultimately, debt financing is an important source of funding for companies seeking to grow through new projects and investments. That’s why I recommend potential investors to examine MON’s Return on Capital Employed (ROCE) in order to see management’s track record at deploying funds in high-returning projects.

To help readers see pass 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.