It’s natural that we all tend to focus on the share price of a company. After all, it is the barometer with which we judge a successful investment. But there are many other ways of sizing up a company when deciding whether to invest or not.
A falling share price can give the impression that a company is undervalued, but digging deeper into the financials can show an investor what they’re really buying into.
To this end, the share price of Tullow Oil (LSE: TLW) has fallen from about 200p in November to just above 50p currently. Yet instead of just saying that the stock is cheap and therefore a buy, I decided to dig a little deeper into the balance sheet and found out some interesting things that deserved to be looked at.
You can clearly see the borrowings for any business by looking at the short-term and long-term liabilities. For Tullow, I’m using the latest balance sheet, which has first-half 2019 results.
If we take short-term liabilities first, we can see that Tullow has outstanding debt of $1.62bn that is due to be repaid within the next 12 months. Given that current assets stand at $2.75bn, this does not worry me too much. It says that Tullow has the liquidity to meet its obligations in the short term. Tullow’s cash balances have remained steady and its inventories have grown from the previous year.
From the perspective of investors, both cash and inventories are considered liquid assets, so this leads me to conclude that the risk of Tullow having financial problems from this part of the balance sheet is very limited, which should be taken as a positive.
However, I do have worries about the long-term liabilities. Tullow’s borrowings stand at $3.285bn. To give you some kind of context, sales revenue in the first six months of 2019 stood at a mere $872m. The long-term debt dwarfs the size of the company. This becomes even more evident when you see that the market capitalization of the firm stands at just over $910m (£700m).
Interest cover is a useful measure for assessing how serious the debt is. Interest cover is operating profit divided by interest charges. In other words, how many times can the company’s profit cover the costs of its debt? Obviously, anything below 1 is serious as it shows that profit alone cannot cover the charges. But really we would like to see a healthy company have a high value. For example, Auto Trader has interest cover of over 30 times.
For Tullow, using operating profit of $387m and interest charges of $158m, the interest cover is 2.5. This does not fill me with much confidence for the longer-term future of the company.
Overall, the Tullow Oil share price could be supported in the short term, because it has good current assets. However, I worry for the company’s health in the longer term, due to the amount of debt relative to the size of the firm. I would be inclined to stay away from the falling share price and look elsewhere, for example, at HSBC.
Jonathan Smith and The Motley Fool UK have no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.