News Article - Surge MentionedDebt watch: How to tell when energy producers get desperate oil99 Share on facebook Share on twitter Share on linkedin Share on google_plusone_share Share on email More Sharing Services ? Jeff Lagerquist, BNN.ca 9:57 PM, E.T. | April 29, 2015 Investing Ideas Tags: Energy, Jeff Lagerquist, Natural Gas, Oil Follow this Oil and gas producers are packing on unheard of levels debt, a trend some warn could exacerbate an already fragile energy sector struggling to turn a profit on what they pull out of the ground. Debt levels from the oil and gas sector ballooned two-and-a-half times in recent years, from $1 trillion in 2006 to around $2.5 trillion in 2014, according to the latest Bank of International Settlements quarterly review. Borrowing has never been more attractive thanks the easier monetary policy, while lower oil prices undermine the value of assets used to back these debts. Slimmer profits increase the risk of default, causing lenders to hike financing costs, and weaker cash flow means firms have to look to less liquid assets to service interest payments. Ken Lin, an analyst at Paradigm Capital, joined BNN to size up a few balance sheets and separate the risk-adverse players that will gain favour in the market from those that are starting to show cracks during the debt surge. “One of the key things we are seeing right now is that companies with more levered balance sheets were hit by the market. If a company is able to reset the balance sheet when you are looking at debt-to-cash flow of under two times, one is even healthier, then the market will reward the company in terms of their equity price appreciation,” he said. Lin points to Surge Energy Inc., which announced the sale of $430 million worth of light oil properties in Saskatchewan and Manitoba to pay down debt and focus capital on their Upper Shaunavon discovery on Monday. Investors looked favourably on the sale, sending the stock up 14 percent at Monday’s close. While the psychological threshold of two times debt-to-cash flow is the most common yardstick for weeding out companies with too much debt on their balance sheets, Lin says there are other measures investors should take into account beyond an estimate of the amount of time it would take a company to repay its debt if it devoted all of its cash flow to debt repayment. “One of the things to look at beyond the debt-to-cash flow . . . is credit facility or credit utilization. If a company has a higher debt-to-cash flow and very little room on its line, it’s a greater corporate risk versus a company that has high debt to cash flow and a lot of room on its credit facility,” he said. ON THE GOOD SIDE OF THE 2X DEBT-TO-CASH FLOW - PARADIGM CAPITAL 2015 ESTIMATE Cardinal Energy Ltd. (CJ.TO 0.25%) – 0.7X Surge Energy Inc. (SGY.TO 1.16%) – 1.5X Torc Oil & Gas Ltd. (TOG.TO 0.38%) – 1.5X Fresh off the analyst consensus that Torc is the buyer of Surge’s production assets, the Calgary-based oil and gas producer’s clean balance sheet falls on Lin’s list of safer energy names riding out volatile commodity markets. “That’s why they’ve been one of the darlings of the market. They had a very clean balance sheet under one times. They’re very close to that even with this acquisition with the issuance of equity,” he said. PUSHING ABOVE 2X DEBT-TO-CASH FLOW - PARADIGM CAPITAL 2015 ESTIMATE Bonterra Energy Corp (BNE.TO 1.06%) – 3.1X Crescent Point Energy Corp. (CPG.TO -0.81%) – 2X Vermilion Inc. (VRML.O -0.55%) – 2.7X Standing by his claim that debt-to-cash flow isn’t an all-encompassing data point, Lin says he likes Bonterra in spite of its debt level for its asset quality and management team. “You have to look beyond the headline cash flow balance sheet metric and examine the corporate net backs, the quality of the assets, whether the company has room on their facility or not to actually withstand the lower commodity environment,” he said. THE DEADLY DOUBLE DIVIDEND CUT While trimming dividend payments and adjusting capital expenditure in the face of weaker commodity prices and an uncertain outlook can be seen as a prudent move from management, Lin says a second dividend cut should considered the canary in the coal mine. “What we’ve seen at the beginning of the year is a lot of these dividend players adjust their dividend to adjust for the lower commodity price. What would be bad is if you adjust your dividend twice. That would maybe signal not a lot of attention in terms of your balance sheet or the commodity price forecast on behalf of management,” he said. Comments