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Current portion of long-term debt or CPLTD refers to that portion of a firm’s balance sheet that keeps records of the total amount of long-term debt that must be paid within the ongoing year.
Let us look at the chart of Exxon above. It tracks the current portion of long-term debt vs non-current portion of long-term debt of Exxon for the past five years. We note that during 2016, Exxon had $13.6 billion of the current portion of long-term debt as compared to $28.39 billion of the noncurrent portion. However, in the year of 2013 and 2014, Exxon’s current portion of long-term debt was far greater than that of the noncurrent portion.
Is this good or bad for Exxon?
In this article, we will discuss the current portion of long-term debt or CPLTD and answer the above question –
- What is the current portion of long-term debt?
- SeaDrill Limited – Current Portion of Long-Term Debt
- How to get to know if the company is a risky investment?
- SeaDrill Limited – A Risk Investment?
- Noble Corp – A Risky Investment?
What is the current portion of long-term debt?
Debt is an obligation because it is borrowed by one party from the another. The one who takes the loan is a debtor and from whom the loan is taken is called lender or creditor. The organizations or corporates uses the debt for making large purchases such as plant, building, and facilities etc. that these firms cannot afford in the normal circumstances. Moreover, the debt is one of the cheapest forms available to firms and corporates for long-term financing and provides an option to a borrower to pay it back at a later date with an interest.
However, the long-term debt has multiple forms that includes bonds, debenture, secured notes, mortgage notes and loans taken from the bank or financial institutions. Thus, from a company’s point of view, the long-term debt means any financial obligations, which are lined up for a period greater than 12 months. However, the company often pays a portion of these long-term obligations or liabilities within the current or ongoing year, which is known as current portion of long-term debt.
SeaDrill Limited – Current Portion of Long Term Debt
SeaDrill Limited (NYSE: SDRL) has a total long-term debt of $9.8 billion and is expected to pay $3.1 billion in the current year. Hence, it recorded $6.6 billion as a long-term debt and $3.1 billion as a current portion of long-term debt at the end of fourth-quarter of 2016.
The snapshot below shows the balance sheet of SeaDrill Limited.
Source: SeaDrill Limited
As observed in the graph above, SeaDrill balance sheet doesn’t paint a good picture because its current portion of long-term debt has increased by 115% on a year-over-year basis. It is because SeaDrill doesn’t have sufficient liquidity to cover its short-term borrowings and current liabilities. In other words, SeaDrill has a high amount of current portion of long-term debt as compared to its liquidity such as cash and cash equivalent. This suggests that SeaDrill will find it difficult to make its payments or pay off its short-term obligation.
Note: The thumb rule states that a company with a high number in its current portion of long-term debt as compared to small cash position has a higher risk of default.
Same goes with SeaDrill that has a high number in its current portion of long-term debt and a low cash position. As a result of this higher CPLTD, the company was on the verge of defaulting. According to simplywall.st, SeaDrill proposed a debt-restructuring plan to survive the industry downturn. As per this scheme, the company plans to renegotiate its borrowings with the creditors and has a plan to defer most of its current portion of long-term debt.
However, this move had a negative impact on its share price performance because the company saw its share price falling more than 15% last month. In fact, this was the second announcement regarding its debt restructuring plan as the company was not able to please the creditors as per its earlier given date of December 30, 2016. This time the company has pushed the deadline to the end of April 2017.
In the case of SeaDrill, the company is not able to pay its current portion of long-term debt due to a historical weakness in the crude oil sector and poor market conditions. For instance, the crude oil prices fell more than 50% since the high of $100 per barrel in 2014 to close to $50 per barrel at present due to the oversupply of crude oil and increase in the inventories in the United States.
How to get to know if the company is a risky investment?
If the current portion of long-term debt has increased, then, you can analyze the company using two ratios – 1) Current Ratio 2) Debt to Equity Ratio.
Let us first understand these concepts before we move the practical analysis.
#1 – Current Ratio
In simple words, the current ratio is part of liquidity ratio that helps to measure a firm’s ability to repay the short as well as long terms obligation. In other words, you can say that it is one of the important indicators of the company’s current and prospective liquidity position. In addition to this, the current ratio provides a sense of the efficiency of a company’s operating cycle by way of analyzing its ability to turn its products and services into cash.
Note: A ratio ranging 1 to 3 is considered that a company has a sound financial health. However, the ratio below 1 and higher than 3 suggest that the company is in question regarding its liquidity or financial health.
A ratio below 1 states that the company may not be able to pay off its obligation. But, it doesn’t mean that the company will go bankrupt as there are many ways for a company to access its financing. For example, the company may have more current debt payable within a year, but it expects a significant return on a project it plans to start in a near future. So, the implementation of the project would have incurred the larger expenses than the initially expected, which in turn, had a negative impact on the current working capital. However, the future earnings of the projects can easily cover these costs and improve its current ratio eventually.
#2 – Debt to Equity Ratio
Apart from the current ratio, there is another ratio namely debt-to-equity ratio that we can take into account assessing the financial risk of the company. Financial risk is the risk of defaulting on the repayment of the company’s liabilities.
Note: if the debt-to-equity ratio is high, it usually increases the probability that the company will default on its debt covenants and as a result will be liquidated. This is not an encouraging sign for investors and the lenders due to the fact that it will increase the risk associated with their investment. In other words, we can say that it will require investors and lenders even a higher rate of return to compensate for the additional risk. Moreover, an increase in the required rate of return would mean an increase in cost of capital of the company.
On the other hand, a lower debt-to-equity ratio would suggest that a company is not entirely using the cheaper sources of finance, which is debt.
Therefore, the ideal range of debt-to-equity ratio is between 0.1 to 0.9. This means the debt-to-equity ratio should not be lower than 0.1 and should not exceed 0.9. Thus, if the debt-to-equity ratio falls outside these acceptable ranges than the company has to take corrective steps such as injection of more equity, divestments of assets to pay off debts, or discontinuation of additional lending.
SeaDrill Limited – A Risk Investment?
Now, let us find out the current ratio of SeaDrill Limited and check if the company is a risky investment or not? The current ratio is the ratio of short-term assets to short-term liabilities. Therefore, the formula that can be used to calculate current ratio is:
#1 – Current Ratio of SeaDrill
Current Ratio = Total current asset / total current liabilities
Now, SeaDrill has total current assets of $2.7 billion and current liabilities of $4.7 billion. Thus, the current ratio of SeaDrill would be 0.57, which is below than stated range between 1 and 3. A primary reason for this low current ratio is the higher amount of current portion of long-term debt, which is $3.1 billion. Hence, the lower current ratio suggests that SeaDrill is a risky investment. It is because the industry SeaDrill operates is currently having a downturn and is not expected to recover in a year or two. Thus, SeaDrill’s vessels such as floaters and jack-ups may not get contracts that should hurt its cash flow from operation.
However, if SeaDrill manages to refinance its current portion of long-term debt into long-term liabilities, then, these current liabilities particularly CPLTD will no longer to be due within next 12 months or so. In the case of SeaDrill, as stated above in this article, SeaDrill is trying to refinance its debt. If the company gets successful refinancing its debt, at that time, the current portion of the long-term debt will be excluded from the current liabilities and it will be reported as long-term liabilities.
Therefore, in this scenario, we will calculate current ratio excluding the impact of the current portion of long-term debt. Hence, after the removal of the current portion of the long-term debt from the current liabilities, its current ratio will come in at 1.68, (2.7/1.6), which is a favorable ratio as it lies in the range between 1 and 3. In this scenario, the company doesn’t remain a risky investment, but it all depends upon if the company is able to refinance its debt.
#2 – Deb to Equity Ratio of SeaDrill
Let us calculate and analyze the financial risk of SeaDrill Limited that will give an even more realistic picture if the company is on the verge of defaulting or not. SeaDrill Limited has total debt of $10.9 billion and owns total shareholder’s equity of $10.1 billion. Hence, its debt-to-equity ratio would come in at 1.09, which is not favorable as it lies outside the range stated above and the company has to take some corrective steps to amend its debt portion.
|Working on Long-term Debt & Shareholder’s Equity|
|Long-term debt related to third parties||330|
|Other current liabilities||1135|
|Total Shareholder’s Equity||10101|
Source: SeaDrill Limited
Noble Corp – A Risky Investment?
Now, let us take an example of Noble Corporation (NYSE: NE) that falls in the same industry (Oil & Gas Drilling & Exploration). However, Noble Corporation has a better current ratio as compared to SeaDrill because the company has kept the proportion of debt lower than its equity. As a result, its current portion of long-term debt is low. Moreover, Noble Corporation continues to lower its current portion of long-term debt on a year-over-year basis, as illustrated in the balance sheet of Noble Corporation.
Source: Noble Corporation
#1 – Current Ratio of Noble Corp
As observed in the snapshot above, Noble Corporation has total current assets of $1,192,614 as against the total current liability of $633,293. As such, the current ratio of Noble Corporation would be 1.8 (1,192,614/633,293). This is quite an attractive and favorable ratio from the investment perspective. A key reason for this favorable current ratio is that the company continues to lower its current portion of long-term debt. For instance, its current portion of long-term debt declined to $299,882 at the end of the fiscal year 2016 as compared to the CPLTD of $299,924 at the end of the fiscal year 2015. In addition, the company was able to lower the other current liabilities such as accrued payroll and related costs, and other current liabilities on a year-over-year basis, as shown in the graph above.
#2 – Debt to Equity Ratio of Noble Corp
Now let us calculate the debt-to-equity ratio of Noble Corporation in order to understand its financial risk position better. Noble Corporation has total debt of $4,816,135 and owns total shareholder’s equity of $6,467,445. Hence its debt-to-equity ratio will come in at 0.74 (4,816,135/6,467,445). This debt-to-equity ratio falls in the range stated above and thus paints an encouraging picture regarding its financial risk.
Therefore, Noble Corporation remains a better candidate for the investment due to its ability to pay the current as well as long-term borrowings consistently. This favorable current ratio would increase its credibility and reliability to the lenders and creditors. Also, it should have a positive impact on the ratings, given by the credit agencies (credit analysis). This, in turn, should improve the value of its shares eventually. The graph below shows the working on the total debt and shareholder’s equity of Noble Corporation.
|Working on Long-term Debt (in thousands)|
|Other long-term debt||299,150|
|Other current liabilities||176,804|
|Total Shareholder’s Equity||6467445|
Debt is an important composition of the company’s total capital. It creates financial leverage, which can multiply the returns on investment provided the returns derived from loan exceeds the cost of loan or debt. However, it all depends if the company is utilizing the debt taken from the bank or other financial institution in a right manner. Meanwhile, the current portion of long-term debt should be treated as a current liquidity as it represents the principal part of the debt payments, which are expected to be paid within next twelve months. If not paid within the current twelve months, it gets accumulated and has an adverse impact on the immediate liquidity of the company. As a result, the company’s financial position becomes risky, which is not an encouraging sign for investors and lenders.