Gaining knowledge about a company’s debt and liabilities is a key component in understanding the risk of a company. An understanding of these factors will aid in the decision to invest, not to invest, or to stay invested in a company. There are many metrics involved in gaining knowledge about the debt of a company, but for this article, I will look at **Pengrowth Energy Corporation’s **(PGH) total debt, total liabilities, debt ratios and WACC.

All material is sourced from Google Finance, Morningstar and the company webpage.

*1. Total Debt = Long-Term Debt + Short-Term Debt*

Total debt is the sum of long-term debt, which is debt that is due in one year or more, and short-term debt, which is any debt that is due within one year.

- 2008 – $1.525 billion + $0 million = $1.525 billion
- 2009 – $982 million + $169 million = $1.151 billion
- 2010 – $1.024 billion + $22 million = $1.046 billion
- 2011 – $1.008 billion + $0 million = $1.008 billion
- 2012 TTM – $1.662 billion + $86 million = $1.748 billion

Pengrowth’s total debt has increased since 2008. In 2008, the company reported a total debt of $1.525 billion. In 2012 TTM, the company’s total debt increased to $1.748 billion. Over the past 5 years, Pengrowth’s total debt has increased by 14.62%.

*2. Total Liabilities*

Liabilities are a company’s legal debts or obligations that arise during the course of business operations, so debts are one type of liability, but not all liabilities. Total liabilities is the combination of long-term liabilities, which are the liabilities that are due in one year or more, and short-term or current liabilities, which are any liabilities due within one year.

- 2008 – $2.654 billion
- 2009 – $1.898 billion
- 2010 – $1.856 billion
- 2011 – $2.297 billion
- 2012 TTM – $2.880 billion

Pengrowth Energy’s liabilities have also increased over the past 5 years. In 2008, the company reported liabilities at $2.654 billion; in 2012 TTM, the company reported liabilities at $2.880 billion. Over the past 5 years, Pengrowth Energy’s liabilities have increased by 8.52%.

In analyzing Pengrowth Energy’s total debt and liabilities, we can see that the company currently has a total debt of $1.748 billion and liabilities at $2.880 billion. Over the past five years, the total debt has increased by 14.62% while total liabilities have increased by 8.52%. As the company’s amount of debt and amount of liabilities have increased over the past 5 years, the next step will reveal if the company has the ability to pay them.

**Debt Ratios**

*3. Total Debt to Total Assets Ratio = Total Debt / Total Assets*

This is a metric used to measure a company’s financial risk by determining how much of the company’s assets have been financed by debt. It is calculated by adding short-term and long-term debt and then dividing by the company’s total assets.

A debt ratio of greater than 1 indicates that a company has more total debt than assets; meanwhile, a debt ratio of less than 1 indicates that a company has more assets than total debt. Used along with other measures of financial health, the total debt to total assets ratio can help investors determine a company’s level of risk.

- 2010 – $1.046 billion / $5.043 billion = 0.21
- 2011 – $1.008 billion / $5.645 billion = 0.18
- 2012 TTM – $1.748 billion / $7.539 billion = 0.23

Over the past three years, Pengrowth Energy’s total debt to total assets ratio has increased. Over the past 3 years, the total debt to total assets ratio has increased from 0.21 in 2010 to 0.23 in 2012. This indicates that since 2010 the company has been adding asset value at a slower rate than its total debt. As the number is currently well below 1, this indicates that the company has more assets than total debt. As the number has been increasing, this states that the risk to the company regarding its debt-to-assets has increased since 2010.

*4. Debt ratio = Total Liabilities / Total Assets*

Total liabilities divided by total assets. The debt ratio shows the proportion of a company’s assets that is financed through debt. If the ratio is less than 0.5, most of the company’s assets are financed through equity. If the ratio is greater than 0.5, most of the company’s assets are financed through debt. Companies with high debt/asset ratios are said to be “highly leveraged.” A company with a high-debt ratio or that is “highly leveraged” could be in danger if creditors start to demand repayment of debt.

- 2010 – $1.856 billion / $5.043 billion = 0.37
- 2011 – $2.297 billion / $5.645 billion = 0.41
- 2012 TTM – $2.880 billion / $7.539 billion = 0.38

In looking at Pengrowth Energy’s total liabilities to total assets ratio over the past three years, we can see that this ratio has also increased. As the numbers are below the 0.50 mark, this indicates that Pengrowth Energy has not financed most of the company’s assets through debt. As the number has only increased slightly, so is the risk to the company.

*5. Debt to Equity Ratio = Total Liabilities / Shareholders’ Equity*

The debt-to-equity ratio is another leverage ratio that compares a company’s total liabilities with its total shareholders’ equity. This is a measurement of how much suppliers, lenders, creditors and obligators have committed to the company versus what the shareholders have committed.

A high debt-to-equity ratio generally means that a company has been aggressive in financing its growth with debt. This can result in the company reporting volatile earnings. In general, a high debt-to-equity ratio indicates that a company may not be able to generate enough cash to satisfy its debt obligations, and therefore is considered a riskier investment.

- 2010 – $1.856 billion / $3.187 billion = 0.58
- 2011 – $2.297 billion / $3.347 billion = 0.69
- 2012 TTM – $2.880 billion / $4.219 billion = 0.68

Over the past three years, Continental Resources debt-to-equity ratio has increased. The ratio has gained from 0.58 to 0.68. As the ratio is currently below 1, this indicates that shareholders have more invested than suppliers, lenders, creditors and obligators. 0.68 indicates a lower amount of risk for the company. As the ratio is below 1 and considered moderately low, so is the risk for the company.

*6. Capitalization Ratio = LT Debt / LT Debt + Shareholders’ Equity*

(LT Debt = Long-Term Debt)

The capitalization ratio tells the investors about the extent to which the company is using its equity to support its operations and growth. This ratio helps in the assessment of risk. Companies with a high capitalization ratio are considered to be risky because they are at a risk of insolvency if they fail to repay their debt on time. Companies with a high capitalization ratio may also find it difficult to get more loans in the future.

- 2010 – $1.024 billion / $4.211 billion = 0.24
- 2011 – $1.008 million / $4.355 billion = 0.23
- 2012 TTM – $1.748 billion / $5.967 billion = 0.29

Over the past three years, Pengrowth Energy’s capitalization ratio has increased from 0.24 to 0.29. This implies that the company has less equity compared with its long-term debt. As this is the case, the company has had less equity to support its operations and add growth through its equity. As the ratio is increasing, financially this implies a slight increase of risk to the company.

*7. Cash Flow to Total Debt Ratio = Operating Cash Flow / Total Debt*

This coverage ratio compares a company’s operating cash flow with its total debt. This ratio provides an indication of a company’s ability to cover total debt with its yearly cash flow from operations. The higher the percentage ratio, the better the company’s ability to carry its total debt. The larger the ratio, the better a company can weather rough economic conditions.

- 2010 – $606 million / $1.046 billion = 0.58
- 2011 – $693 million / $1.008 billion = 0.69
- 2012 TTM – $551 million / $1.748 billion = 0.31

Over the past three years, the cash flow to total debt ratio has decreased. The ratio has decreased from 0.71 in 2010 to 0.53 in 2012 TTM. As the ratio is below 1, this implies that the company does not have the ability to cover its total debt with its yearly cash flow from operations.

Based on the five debt ratios listed above, we can see the company has increased its debt and liabilities over the past three years. We can also see that the company’s debt and liabilities have increase slightly more than the company’s assets. This does indicate a slight increase in risk compared to three years ago but as the ratios are very low and show no signs of financial distress, no red flags are raised. The next step will reveal how much the company will pay for the debt incurred.

**Cost of Debt**

The cost of debt is the effective rate that a company pays on its total debt.

As a company acquires debt through various bonds, loans and other forms of debt, the cost of debt metric is useful, because it gives an idea as to the overall rate being paid by the company to use debt financing.

This measure is also useful because it gives investors an idea as to the riskiness of the company compared with others. The higher the cost of debt, the higher the risk.

*8. Cost of debt (before tax) = Corporate Bond rate of company’s bond rating.*

- due April 2013 Rate of 5.47% = 5.47%
- Current cost of Debt as of January 22nd 2013 = 5.47%

*9. Current tax rate (Income Tax total / Income before Tax)*

- 2008 – $72 million / $324 million = 22.22%
- 2009 – $(143) million / $(58) million =
- 2010 – $(45) million / $185 million =
- 2011 – $22 million / $107 million = 20.56%
- 2012 TTM – $(36) million / $(37) million =

Based on the 2 years Pengrowth taxes were able to be calculated with a positive number the average tax rate = 21.39%

*10. Cost of Debt (After Tax) = (Cost of debt before tax) (1 – tax rate)*

The effective rate that a company pays on its current debt after tax.

- .0547 x (1 – .2139) = Cost of debt after tax

The cost of debt after tax for Pengrowth Energy is *4.30%*

**Cost of equity or R equity =** Risk free rate + Beta equity (Average market return – Risk free rate)

The cost of equity is the return a firm theoretically pays to its equity investors, for example, shareholders, to compensate for the risk they undertake by investing in their company.

- Risk free rate = U.S. 10-year bond = 1.87% (Bloomberg)
- Average market return 1950 – 2012 = 7%
- Beta = (Google Finance) Pengrowth Energy’s beta = 0.88

Risk free rate + Beta equity (Average market return – Risk free rate)

- 1.87 + 0.88 (7-1.87)
- 1.87 + 0.88 x 5.13
- 1.87 + 4.51 = 6.38%

Currently, Pengrowth Energy has a cost of equity or R Equity of 6.38%, so investors should expect to get a return of 6.38% per-year average over the long term on their investment to compensate for the risk they undertake by investing in this company.

(*Please note that this is the CAPM approach to finding the cost of equity. Inherently, there are some flaws with this approach and that the numbers are very “general.” This approach is based off of the S&P average return from 1950 – 2012 at 7%, the U.S. 10-year bond for the risk-free rate which is susceptible to daily change and Google finance beta.*)

**Weighted Average Cost of Capital or WACC**

The WACC calculation is a calculation of a company’s cost of capital in which each category of capital is equally weighted. All capital sources such as common stock, preferred stock, bonds and all other long-term debt are included in this calculation.

As the WACC of a firm increases, and the beta and rate of return on equity increases, this states a decrease in valuation and a higher risk.

By taking the weighted average, we can see how much interest the company has to pay for every dollar it finances.

For this calculation, you will need to know the following listed below:

Tax Rate = 21.39% (Pengrowth Energy’s current Tax Rate)

Cost of Debt (before tax) or **R debt** = 5.47%

Cost of Equity or **R equity** = 6.38%

Debt (Total Liabilities) for 2011 or **D** = $2.880 billion

Stock Price = $4.80 (January 22nd, 2013)

Outstanding Shares = 507.14 million

Equity = Stock price x Outstanding Shares or **E** = $2.434 billion

Debt + Equity or **D+E** = $5.314 billion

**WACC** = R = (1 – Tax Rate) x R debt (D/D+E) + R equity (E/D+E)

(1 – Tax Rate) x R debt (D/D+E) + R equity (E/D+E)

(1 – .2139) x .0547 x ($2.880/$5.314) + .0638 ($2.434/$5.314)

.7861 x .0547 x .5420 + .0638 x .4580

.0233 + .0292

= 5.25%

Based on the calculations above, we can conclude that Pengrowth Energy pays 5.25% on every dollar that it finances, or 5.25 cents on every dollar. From this calculation, we understand that on every dollar the company spends on an investment, the company must make $.0525 plus the cost of the investment for the investment to be feasible for the company.

**Summary**

In analyzing Pengrowth Energy’s total debt and liabilities, we can see that the company currently has a total debt of $1.748 billion and liabilities at $2.880 billion. Over the past five years, the total debt has increased by 14.62% while total liabilities have increased by 8.52%.

In reviewing the five debt ratios listed above, we can see the company has increased its debt and liabilities over the past three years. We can also see that the company’s debt and liabilities have increase slightly more than the company’s assets. This does indicate a slight increase in risk compared to three years ago but as the ratios are very low and show no signs of financial distress, no red flags are raised.

The CAPM approach for cost of equity states that shareholders need 6.38% average per year over a long period of time on their equity to make it worthwhile to invest in the company. This calculation is so based on the average market return between 1950 and 2012 at 7%.

The WACC calculation reveals that the company pays 5.25% on every dollar that it finances. As the current WACC of Pengrowth Energy is currently 5.25% and the beta is below average at 0.88, this implies that the company needs at least 5.25% on future investments and will have below average volatility moving forward.

The analysis of Pengrowth Energy’s debt and liabilities indicates a company that has increased its liabilities over the past 3 years. The analysis also reveals that the company’s assets growth rate has also increased over the past 3 years. When compared to each other the ratio’s calculate a slightly greater increase in debt and liabilities over assets. As the ratios are very low this currently does not raise concern but is something to watch moving forward. The WACC reveals that Pengrowth Energy has the ability to add future investments and assets at around 5.25%. Currently, Pengrowth has the ability to pay for its debts, meet its obligations, while adding growth.

All indications above reveal a sound company who’s debt and liabilities has increased more than its assets. This currently does not pose any problems from an analytical point of view but is something to watch moving forward. The CAPM reveals that the investor needs 6.38%. return so, if you believe that you can get 6.38% year over year over the long term on this investment then you will get good value on your investment.

As originally posted on Oiprice.com

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