Are Advantage Oil & Gas Ltd’s (TSE:AAV) Interest Costs Too High?

While small-cap stocks, such as Advantage Oil & Gas Ltd (TSX:AAV) with its market cap of CA$716.88M, are popular for their explosive growth, investors should also be aware of their balance sheet to judge whether the company can survive a downturn. Companies operating in the Oil and Gas industry, even ones that are profitable, are inclined towards being higher risk. Evaluating financial health as part of your investment thesis is crucial. Here are a few basic checks that are good enough to have a broad overview of the company’s financial strength. Nevertheless, this commentary is still very high-level, so I suggest you dig deeper yourself into AAV here.

How does AAV’s operating cash flow stack up against its debt?

Over the past year, AAV has ramped up its debt from CA$153.10M to CA$208.98M , which is made up of current and long term debt. With this rise in debt, AAV currently has CA$6.92M remaining in cash and short-term investments , ready to deploy into the business. On top of this, AAV has generated cash from operations of CA$186.40M over the same time period, resulting in an operating cash to total debt ratio of 89.20%, indicating that AAV’s operating cash is sufficient to cover its debt. This ratio can also be a sign of operational efficiency as an alternative to return on assets. In AAV’s case, it is able to generate 0.89x cash from its debt capital.

Does AAV’s liquid assets cover its short-term commitments?

Looking at AAV’s most recent CA$51.12M liabilities, it seems that the business has been able to meet these commitments with a current assets level of CA$70.29M, leading to a 1.38x current account ratio. Usually, for Oil and Gas companies, this is a suitable ratio since there is a bit of a cash buffer without leaving too much capital in a low-return environment.

TSX:AAV Historical Debt Jun 6th 18
TSX:AAV Historical Debt Jun 6th 18

Can AAV service its debt comfortably?

With a debt-to-equity ratio of 17.94%, AAV’s debt level may be seen as prudent. AAV is not taking on too much debt commitment, which may be constraining for future growth. We can test if AAV’s debt levels are sustainable by measuring interest payments against earnings of a company. Ideally, earnings before interest and tax (EBIT) should cover net interest by at least three times. For AAV, the ratio of 12.87x suggests that interest is comfortably covered, which means that lenders may be less hesitant to lend out more funding as AAV’s high interest coverage is seen as responsible and safe practice.

Next Steps:

AAV’s high cash coverage and low debt levels indicate its ability to utilise its borrowings efficiently in order to generate ample cash flow. Furthermore, the company exhibits proper management of current assets and upcoming liabilities. This is only a rough assessment of financial health, and I’m sure AAV has company-specific issues impacting its capital structure decisions. You should continue to research Advantage Oil & Gas to get a better picture of the stock by looking at:

  1. Future Outlook: What are well-informed industry analysts predicting for AAV’s future growth? Take a look at our free research report of analyst consensus for AAV’s outlook.
  2. Valuation: What is AAV worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether AAV is currently mispriced by the market.
  3. Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.