Why investors should understand debt ratios

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Debt ratios

In the last part in the series, we analyzed National Oilwell Varco’s (NOV) equity-related valuation ratios. In this part of the series, we’ll analyze its debt-related ratios to find out how healthy NOV is in regards to debt.

NOV - P13

We’ve already discovered that in each of the last seven years, and even today, NOV could have paid off all of its debts. It would still have a decent amount of cash left.

We’ll look at the comfortable debt situation in different contexts. Investors and creditors usually watch a company’s debt situation. They watch the debt situation to gauge a company’s ability to maintain, add, or repay its debts.

Net cash

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The company’s net debt—debt less cash—actually shows up as a negative number in the above table. When these numbers are scaled by various items—like earnings before interest, taxes, depreciation, and amortization (or EBITDA), equity, or total capital—the ratios are also negative. This is a good thing!

Total debt

We know that NOV’s debt has grown substantially, especially in the last couple of years. We discussed NOV’s balance sheet in Part 6 in this series.

So, we need to scale the yearly total debt numbers by other items—like EBITDA, equity, and total assets—to get an idea of how much NOV’s debt has grown relative to the overall company’s growth.

Even though NOV’s debt levels relative to its assets, equity, and EBITDA increased in the last couple of years, it’s still at very comfortable levels.

For example, even at the end of 2013, NOV generated enough EBITDA to pay off all of its debts at once.

Interest expense

Debts bring interest expenses. NOV’s EBITDA was high enough and its interest expenses were low enough. The EBITDA could cover the interest expenses several times over.

This is true even when we deduct NOV’s capital expenditures from its EBITDA.

Liabilities

Ratios like the quick and current ratio show how comfortably a company can pay of its short-term liabilities. Numbers above one—like NOV’s—are good.

Key peers and exchange-traded funds (or ETFs)

NOV’s good fortunes have also been experienced by its oil and gas service and equipment industry peers—like Schlumberger (SLB), Baker Hughes (BHI), and Weatherford International (WFT). The VanEck Vectors Oil Services ETF (OIH) is a great way for investors to gain low-cost and diversified exposure to this sector.

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