Strengthening the Balance Sheet

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Steps to becoming well-capitalized

Brooke Valentine, Clinton Roberts, David Bryan and Tim Nakaska discuss how energy sector companies can shore up their balance sheet.

In Brief
In Brief
Business in the energy sector has slowed and capital is scarce. Organizations that build sustainability into their capital structures will position their companies for success.

A slowdown in exploration, production and capital spending is hitting the energy sector, which benefited from strong earnings from 2005 through mid-2008. The cash generated from those earnings is dwindling and some companies are now running out of available cash.

The downturn is also exposing a truth about the Alberta economy that often gets overlooked. Natural gas production represents a major component of the province’s economy and yet changes in oil prices dominate headlines. But today, with the price of natural gas dropping to a seven-year low and inventories reaching a record high, the situation has changed, especially for firms more weighted towards gas.

“As a result, those junior gas companies are encountering financial challenges in terms of raising additional capital, be it equity or debt,” says Brooke Valentine, an associate partner at PricewaterhouseCoopers Corporate Finance (PwCCF) Inc. in Calgary."

It’s not just the natural gas firms that are hurting, but the energy services companies are also feeling the effect.

“The challenge there is not that they don’t have much work, they have no work,” explains Stephen Kent, a former managing director at PwCCF in Edmonton. "A lot of the work they did came from the gas sector, which may take some time to recover."

This is a critical time for the sector. Companies with a large exposure to natural gas must find ways to become better-capitalized to thrive in order to survive.

Borrowing is a great option as interest rates are near record lows. The problem is actually borrowing because it’s harder to get loans. Banks are more cautious today than they were a year ago.

“If a company gets a loan, the covenants it has to comply with are stiffer than they were a year ago. Those lucky companies have a low interest rate,” says Valentine. “For the others, the low interest rate is of little benefit because they can not borrow more or borrow at all or risk heavy fees for renegotiations on covenant breaches.”

If borrowing isn’t an option, companies can search for alternate sources of capital. Private firms can try a private placement, but they’re difficult in today’s market, particularly for smaller companies. Public companies can look at selling additional equity “but most of them are trading at historically low valuations so it’s very dilutive,” according to Kent. “They really don’t want to do it.”

An easier way to shore up the balance sheet is to go after receivables already on the books in order to convert that to cash. Selling assets that are non-core to the business is another option. The sale and leaseback of property is also something that is becoming more common. If a company owns its own real estate, it can sell it and lease it back, helping to provide a cash infusion into the business.

PwCCF recommends that companies take a proactive approach with their lender. This includes providing a lender with dynamic financial forecasts that allow for sensitivity analysis. “Lenders tend to be more accommodating to borrowers that engage in open and frank discussions,” says Valentine.

For companies in better shape and a strong balance sheet, Valentine and Kent say now may be the best time to consider growing through acquisitions.

“We think there’s a lot of upside potential in that kind of activity. You can buy a lot of market share at an attractive price,” Valentine says. “Geographic expansion is another thing I think they should be pursuing. There are some signs that the Alberta oil and gas sector may be comparatively weaker than elsewhere, particularly the United States.”

A strong balance sheet will also make it easier for companies to purchase competitors with financial problems at an attractive price.

“There are lots to be picked off but they don’t seem to be doing it yet. They’re sitting,” says Kent. “They should definitely be trying to diversify but they’re not.”