Are MEG Energy Corp’s (TSE:MEG) Interest Costs Too High?

MEG Energy Corp (TSX:MEG) is a small-cap stock with a market capitalization of CA$1.41B. While investors primarily focus on the growth potential and competitive landscape of the small-cap companies, they end up ignoring a key aspect, which could be the biggest threat to its existence: its financial health. Why is it important? Companies operating in the Oil and Gas industry, even ones that are profitable, are inclined towards being higher risk. So, understanding the company’s financial health becomes vital. Here are few basic financial health checks you should consider before taking the plunge. Nevertheless, this commentary is still very high-level, so I’d encourage you to dig deeper yourself into MEG here.

Does MEG generate enough cash through operations?

MEG has shrunken its total debt levels in the last twelve months, from CA$5.07B to CA$4.69B , which is made up of current and long term debt. With this debt repayment, MEG currently has CA$477.19M remaining in cash and short-term investments , ready to deploy into the business. Additionally, MEG has generated cash from operations of CA$317.94M in the last twelve months, leading to an operating cash to total debt ratio of 6.78%, indicating that MEG’s debt is not appropriately covered by operating cash. This ratio can also be a sign of operational efficiency as an alternative to return on assets. In MEG’s case, it is able to generate 0.068x cash from its debt capital.

Can MEG pay its short-term liabilities?

At the current liabilities level of CA$525.46M liabilities, it appears that the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 1.6x. 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:MEG Historical Debt Mar 26th 18
TSX:MEG Historical Debt Mar 26th 18

Can MEG service its debt comfortably?

MEG is a highly-leveraged company with debt exceeding equity by over 100%. This is not uncommon for a small-cap company given that debt tends to be lower-cost and at times, more accessible. We can check to see whether MEG is able to meet its debt obligations by looking at the net interest coverage ratio. A company generating earnings before interest and tax (EBIT) at least three times its net interest payments is considered financially sound. In MEG’s, case, the ratio of 0.43x suggests that interest is not strongly covered, which means that lenders may refuse to lend the company more money, as it is seen as too risky in terms of default.

Next Steps:

MEG’s cash flow coverage indicates it could improve its operating efficiency in order to meet demand for debt repayments should unforeseen events arise. However, the company will be able to pay all of its upcoming liabilities from its current short-term assets. Keep in mind I haven’t considered other factors such as how MEG has been performing in the past. I recommend you continue to research MEG Energy to get a better picture of the stock by looking at: