A company finances its operations with a combination of debt (money borrowed from financial institutions) and equity (money raised by owners or investors).
While debt gives a company the leeway to finance future expansion plans that deliver a higher returns to shareholders in form of higher dividend and share appreciation, too much of it could threaten the existence of an entity.
This is because profitability will be eroded as interest expense (interest on money borrowed) continues to eat into operating profit.
A highly indebted (leveraged) firm is prone to be liquidated, and its assets shared among creditors who have a claim to its assets, but shareholders, being risk takers, will receive nothing.
Seplat Petroleum Development Company Plc, an upstream oil and gas giant, is in a better position to replace oil fields to increase its share of the market than peer rivals because it has a benign total asset to equity ratio.
An asset to Shareholder Equity is a measurement of financial leverage. It shows the ratio between the total assets of the company to the amount on which equity holders have a claim.
A ratio above 2 means that the company funds more assets by issuing debt than by equity, which could be a more risky investment. A low ratio could be seen as more conservative.
Read also: Seplat, Nestle, 15 others cause stock market to close in red
Also, if a business has a high ratio, it is more susceptible to pricing attacks by competitors, since it must maintain high prices in order to generate the cash flow to pay for its debt.
As of June 2019, Seplat’s asset to equity ratio stood at 1.53 times, this compares with peer rival Oando Nigeria’s ratio of 3.67 times. Simply put, this means Seplat assets are 1.53 times equity.
The chart below shows Seplat’s leverage position has been improving since 2017 after it surmounted the headwinds caused by a precipitous drop in crude oil prices. In 2016, the company’s production was disrupted due to attacks on Forcados Terminal by Niger Delta militants.
Analysts attribute Seplat healthy balance sheet to the savvy management and board of directors, who ensured they cut down on capital expenditure spend at the zenith of a turbulent period.
The upstream oil and gas giant is in a position to make acquisition and bid for assets when the need arises, and banks will be willing to borrow the company money because of its excellent credit profile.
“Those guys in Seplat are professionals who understand the metrics of the oil and gas business. They know the business. These guys were ex Shell and Chevron workers with vast experience in proven reserves,” said an industry expert, who doesn’t want his name mentioned.
In 2015, Oando’s asset to equity ratio was as high as 118.36 times, and the company had to sell asset to keep down the ratio (See Chart).
Seplat’s cash flows from operating activities for the first six months was $255.2million, up 4 percent compared to $245.40 million recorded in the corresponding period of 2018.
Oil and gas firms in Africa’s largest economy will have to drill more oil when prices are low, as global macroeconomic uncertainties continue to spook investors.
Oil prices spiked on Friday morning as trade war negotiations appeared to take a positive turn while Iran reported an oil tanker attack as tensions in the Middle East soar.
Brent Crude Oil closed at $60.52 as of 12:00 pm on Friday while West Texas Intermediate (WTI) stood at $54.70.
