3 Financial Statement Analysis
3.4 Analysis of credit risk
In this chapter, we will discuss the short term as well as the long-term aspect to credit risk in Detnor, and subsequently compare it with our peer group, under the framework presented by Penman87. This means that we do not use average balance sheet figures, but the actual figures in the respective years. The short-term liquidity ratios will discuss the companies’ ability to pay their near future debt obligations, and see whether these findings are industry standard, or if Detnor can be considered an outlier. The second part of the credit analysis relates to the long-term solvency ratios that incorporate the long-term assets and liabilities, in order to understand both the short and long-term ability.
87 Penman, Stephen H. (2003): “Financial Statement Analysis and Security Valuation”
-14% -26% -15% -51% -64%
7% 16% 3%6% 33% 14% -8% -68%
13% 18% 10% -7% N.A.
9% 18% 10% 1% -3%
15% 25% 29% 17% -11%
15% 14% 4% -27% -25%
23% -1% 11% -22% -25%
13% 18% 10% -8% -18%
2 0 1 1 2 0 1 2 2 0 1 3 2 0 1 4 2 0 1 5
R O C E
Det Norske Oljeselskap Lundin Petroleum Enquest Premier Oil Soco International Nostrum Oil & Gas Tullow Oil Faroe Petroleum Median
22495%
3.4.1 Detnor
3.4.1.1 Short-term liquidity stock ratios
The current ratio88 of a company measures the degree to which current assets are able to cover all near-term liabilities89. This measure assumes that all current assets can be converted into cash, but does not take into account the time it takes for the assets to be converted. 26% (2015) to 64% (2010) of Detnor’s total current assets consist of tax receivable in the analyzed period, with the exception of 2014 where they had a tax payable. The inventories are mainly equipment for drilling and exploration wells or spare parts, and can considered fairly liquid in a functioning market. The latter is however not an assumption to take for granted in a struggling oil and oil service market, and thus the subsequent ratio’s might have a better explanatory power in the short term liquidity analysis of Detnor.
By subtracting inventories from the Detnor’s current assets, the numerator yields assets that are easily converted to cash in the short run, and yields a ratio known as the quick ratio90. This ratio mitigates the risk of not being able to convert the asset to cash, but still, there is a risk inherent in the accounts receivable.
However, the lion’s share of the numerator in Detnor consists of tax receivable, which we consider a fairly safe item in Norway, and thus the quick ratio may indeed paint a fair picture of Detnor’s liquidity in the short run. Taking short-term liquidity measures to the extreme, we can look at the cash ratio91, which limits the inherent risk to contain risk associated with the financial system. The short-term derivatives are considered secure as they are traded with financial institutions, and not over the counter (OTC)92. The same argument applies for cash and short-term investments.
The following graphs summarizes the previous discussion applied to Detnor’s financial statements.
Specifications can be found in the appendix.
88 Current ratio = Current assets / Current liabilities
89 Penman, Stephen H. (2003): “Financial Statement Analysis and Security Valuation”. Page 686
90 Quick ratio = (Cash + short term investments + receivables ) / Current liabilities
91 Cash ratio = (Cash + short term investments ) / Current liabilities
92 Detnor Annual Report 2015. Page 106 0 5 10 15
0 1 2 3
2010 2011 2012 2013 2014 2015 Millions
Current ratio
Current assets Current liabilities Current ratio
0 5 10 15
0 1 2 3
2010 2011 2012 2013 2014 2015 Millions
Quick ratio
Quick assets Current liabilities Quick ratio
0 5 10
0 0,2 0,4 0,6 0,8 1
2010 2011 2012 2013 2014 2015 Millions
Cash ratio
Cash assets Current liabilities
Cash ratio
Evidently, both current, quick, and cash ratios have incurred high volatility over the last six years, with a peak in 2011 for the current and quick ratio. The peak comes from a sudden drop in current liabilities due to lower short-term borrowings related to an Exploration Facility (overdraft facility) in 2011.
Comparing Detnor with its peers, we identify that the current ratio is, and has been since 2010, fairly low compared to the peer group. With a current ratio hovering between approximately 1.1 and 1.7, Detnor have experienced a lower current ratio than the median (Detnor excluded) in the peer group for three out of a total of 6 years. Detnor’s high accounts receivables would otherwise increase the ratio, but its already
high level relative to peers might indicate lower liquidity.
3.4.1.2 Long term solvency stock measures
In assessing the long-term solvency measures, we look at the debt level relative to the assets and equity93, respectively. Debt to total assets and debt to equity94 tell the same story from a different angle95, where a higher level indicates higher long-term liquidity risk. The long-term debt ratio96 however, shows long-term debt relative to long-term debt and equity.
The debt to total assets ratio shows us that debt has grown to become almost the same size as the total assets, which in return indicates that Detnor has an increasing long-term liquidity risk. As previously
93 Debt to total assets = Total debt / Total assets
94 Debt to equity = Total debt / Total equity
95 Penman, Stephen H. (2003): “Financial Statement Analysis and Security Valuation”. Page 686
96 Long term debt ratio = Long term debt / (Long term debt + total equity)
1,47 2,76 1,71 2,01 1,07 1,23
1,49 0,74 0,78 0,77 1,02 1,28
1,30 2,15 1,36 0,74 1,22 1,64
1,39 0,90 0,99 1,55 1,13
6,30 3,98 3,62 5,26 3,84 3,99
1,91 1,48 2,79 2,49 4,02 3,07
0,90 0,76 1,05 1,44 1,56 1,16
4,37 3,51 1,95 1,76 1,85 1,93
1,49 1,48 1,36 1,55 1,56 1,78
2 0 1 0 2 0 1 1 2 0 1 2 2 0 1 3 2 0 1 4 2 0 1 5
C U R R E N T R A T I O
Det Norske Oljeselskap Lundin Petroleum Enquest Premier Oil Soco International
Nostrum Oil & Gas Tullow Oil Faroe Petroleum Median
0 20 40 60 80 100
0 0,2 0,4 0,6 0,8 1
2010 2011 2012 2013 2014 2015 Millions
Debt to total assets
Total assets (Liabilities + total equity) Total debt (current + long-term) Debt to total assets
0 20 40 60
0 5 10 15 20
2010 2011 2012 2013 2014 2015 Millions
Debt to equity
Total debt Total equity
Debt to equity
0 10 20 30 40 50
0 0,2 0,4 0,6 0,8 1
2010 2011 2012 2013 2014 2015 Millions
Long term debt ratio
Total equity Long-term debt
Long-term debt ratio
introduced, with the acquisition of Marathon Oil in 2014, the total assets increased substantially, alongside an increase in the credit facilities. The same findings are applicable to the long-term debt ratio, where it is evident that the long-term debt has increased substantially, whereas the book value of equity is much more stable.
Comparing Detnor to its peers, we see that Detnor has been in the upper half of the table in most years in the analyzed period, with the debt equity ratios generally increasing across the peer group after the oil price plunge in 2014. Comparing Detnor to Lundin with regards to the debt equity ratio, there is evidently some sort of correlation between the two. Lundin’s negative debt equity ratio is driven by a negative book value of equity driven by negative earnings, and thus this measure in 2015 is not very useful. The debt side of the story however tells the same tale as for Detnor; debt has increased significantly during the past two years.
3.4.1.3 Long term solvency flow measures
For the flow measures of long-term liquidity risk assessment, we will analyze the interest coverage ratio97. The interest coverage ratio tells us whether the company is able to meet its financial obligations in a given year, based on its profits. It can be argued that operating income should be on a before tax basis, but also after tax98. Furthermore, separating core and non-core operations can be beneficial to analyze whether main operations are enough to cover the interests. We will thus rely on before tax, after tax, and core operating income in the numerator, with the appropriate denominator. Where operating income refers to the core business of Detnor. EBITDA is included in the analysis due to the non-cash effect of depreciation and amortization.
97 Interest coverage before tax = Operating income / Net interest expense
98 Penman, Stephen H. (2003): “Financial Statement Analysis and Security Valuation”. Page 687
1,44 1,10 1,24 2,31 7,26 14,31
1,43 1,51 1,63 2,45 9,93 -11,09
0,65 1,09 0,97 1,39 2,01 4,66
1,68 1,51 1,48 1,74 2,25
0,16 0,16 0,22 0,26 0,31 0,32
1,27 1,23 1,31 1,12 1,41 1,83
1,16 1,23 0,76 1,11 1,84 2,57
0,55 0,65 0,99 0,93 0,97 1,02
1,16 1,23 0,99 1,12 1,84 1,42
2 0 1 0 2 0 1 1 2 0 1 2 2 0 1 3 2 0 1 4 2 0 1 5
D E B T T O E Q U I T Y
Det Norske Oljeselskap Lundin Petroleum Enquest Premier Oil Soco International Nostrum Oil & Gas Tullow Oil Faroe Petroleum Median
From the graphs we see that the interest coverage has increased significantly in the last few years, due to a positive development in operating profits. The operating income after tax (right hand graph) does however not display any clear pattern, and is much more volatile. All in all, we can expect that due to the revenue enhancement from producing fields, either developed or acquired, the operating profits should increase.
Assuming a stable LIBOR, the interest expenses should stay at the same level, hence interest coverage ratios should increase.
3.4.1.4 Covenant analysis
As mentioned, the Marathon Oil acquisition required a significant increase in Detnor’s credit facilities.
Attached to the credit facilities there were covenants related to both leverage, interest cover and operating cash flow99. The latter is related to short- and long-term projections made by Detnor, which is beyond the scope of this thesis, and thus only the two former will be analyzed here.
Leverage covenant: Net debt / EBITDAX < 3.5x
Interest cover covenant: EBITDA / Interest expense > 3.5x
Apparent from the following graphs, we see that in 2015, Detnor satisfied both of their covenants. Detnor’s leverage (Net debt / EBITDAX) was 3.2, whereas the interest coverage (EBITDA / Interest expense) was 8.7, both inside the required range.
99 Detnor Annual Report 2015. Page 100 -4 -2 0 2
-20 -15 -10 -5 0 5
2010 2011 2012 2013 2014 2015 Millions
Interest coverage before tax (EBIT)
Net interest expense Operating income (EBIT) Interest coverage (before tax) EBIT
-5 0 5 10
-20 -10 0 10
2010 2011 2012 2013 2014 2015 Millions
Interest coverage before tax (EBITDA)
Net interest expense EBITDA
Interest coverage (before tax) EBITDA
-2 -1 0 1 2
-6 -4 -2 0
2010 2011 2012 2013 2014 2015 Millions
Interest coverage after tax (Operating income)
Net interest expense Operating income Interest coverage (after tax)
3.4.2 Liquidity analysis summary
The 2014 acquisition of Marathon Oil brought with it both assets and liabilities. The short-term liquidity risk defined by the current ratio and quick ratio shows a negative trend over the analyzed period, and from 2014, current assets are barely sufficient to cover the current liabilities. The liquidity of the current assets items is considered fairly high, which enhances Detnor’s otherwise downward facing liquidity story, with mediocre short-term liquidity assessments compared to peers.
In the long-term, we see that debt levels are not surprisingly increased, due to the financing needs of the Marathon Oil acquisition. Debt levels across the industry are similarly increasing, though at a lower rate. The main driver of the increased debt are the credit facilities introduced in 2014 and 2015 related to the acquisition activity, and thus the effect on debt from organic growth itself would probably be lower. We consider the higher level of debt to be a normal effect of a struggling oil market. However long term solvency is under pressure, should the market downturn persist.
Detnor is currently able to sustain an acceptable level of leverage and interest coverage related to the covenants on their credit facilities. With production facilities in place from 2014, revenue should increase in the next years, hence these covenants should not be breached as long as LIBOR and NIBOR do not increase significantly, but could potentially come under pressure at low oil prices100.