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Are Horizon Oil Limited's (ASX:HZN) Interest Costs Too High?

Simply Wall St

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While small-cap stocks, such as Horizon Oil Limited (ASX:HZN) with its market cap of AU$137m, are popular for their explosive growth, investors should also be aware of their balance sheet to judge whether the company can survive a downturn. Evaluating financial health as part of your investment thesis is crucial, as mismanagement of capital can lead to bankruptcies, which occur at a higher rate for small-caps. We'll look at some basic checks that can form a snapshot the company’s financial strength. However, this is just a partial view of the stock, and I suggest you dig deeper yourself into HZN here.

HZN’s Debt (And Cash Flows)

Over the past year, HZN has reduced its debt from US$120m to US$83m , which includes long-term debt. With this debt payback, HZN currently has US$20m remaining in cash and short-term investments to keep the business going. On top of this, HZN has generated US$68m in operating cash flow during the same period of time, resulting in an operating cash to total debt ratio of 82%, indicating that HZN’s operating cash is sufficient to cover its debt.

Can HZN pay its short-term liabilities?

At the current liabilities level of US$57m, it seems that the business may not be able to easily meet these obligations given the level of current assets of US$43m, with a current ratio of 0.75x. The current ratio is calculated by dividing current assets by current liabilities.

ASX:HZN Historical Debt, June 11th 2019

Is HZN’s debt level acceptable?

With debt reaching 65% of equity, HZN may be thought of as relatively highly levered. This is somewhat unusual for small-caps companies, since lenders are often hesitant to provide attractive interest rates to less-established businesses. We can check to see whether HZN 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 HZN's, case, the ratio of 3.53x suggests that interest is appropriately covered, which means that debtors may be willing to loan the company more money, giving HZN ample headroom to grow its debt facilities.

Next Steps:

HZN’s high cash coverage means that, although its debt levels are high, the company is able to utilise its borrowings efficiently in order to generate cash flow. However, its lack of liquidity raises questions over current asset management practices for the small-cap. This is only a rough assessment of financial health, and I'm sure HZN has company-specific issues impacting its capital structure decisions. I recommend you continue to research Horizon Oil to get a better picture of the stock by looking at:

  1. Valuation: What is HZN 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 HZN is currently mispriced by the market.
  2. Historical Performance: What has HZN's returns been like over the past? Go into more detail in the past track record analysis and take a look at the free visual representations of our analysis for more clarity.
  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.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.