Net debt to EBITDA
As offshore drilling (XLE) (IYE) is a capital-intensive industry, a huge amount of debt on the balance sheet is common, which we have already seen in the previous article. This should not worry investors, but it is important for them to know whether a company has the capacity to repay its debt obligation.
The net debt-to-EBITDA (earnings before interest, taxes, depreciation, and amortization) ratio tells us how many years it will take for a company to repay its debt if net debt and EBITDA remain stay constant. Net debt is calculated as total debt minus cash and cash equivalents.
Comparing capacity to repay debt
Seadrill (SDRL) has the highest net debt-to-EBITDA ratio of 3.87. This ratio is slightly concerning for the company. In 2Q15, the company had to amend its debt covenants with respect to this ratio and now needs to pay higher interest against the amendment. Seadrill is obligated to pay 15% of its total debt until June 2016 and another 16% until June 2017.
Rowan Companies (RDC) has the second highest ratio of 3.08, followed by Diamond Offshore (DO) with a ratio of 2.64. In terms of repayment of debt, Ensco (ESV) is safest of these companies, with a net debt-to-EBITDA ratio of 2.18. Also the company does not have any repayment obligations for the next four years.
Along with the long-term solvency of a company, investors should also look at its liquidity position. Current ratio, which is calculated as current assets divided by current liabilities, tells us the ability of the company to pay its short-term obligations using its short-term assets. The higher the ratio, the better the company’s position to pay its short-term liabilities. A lower ratio suggests a possible liquidity crunch. These ratios play an important role, especially when the industry is in a bad phase and the companies aren’t able to generate sufficient free cash flow.
Along with an excellent solvency position, Ensco (ESV) has a very comfortable liquid ratio of 2.84. Rowan Companies’s (RDC) ratio of 2.00 also suggests a very sound liquidity position. Seadrill (SDRL) and Diamond Offshore (DO), with liquidity ratios of 0.92 and 0.80, respectively, have liabilities that exceed current assets. These companies may need to use revolving credit to finance their current liabilities.