CAPITAL STRUCTURE ANALYSIS

The capital structure of a firm shows which portion of the firm is financed by debt and which portion is financed by equity. These portions are all shown on the balance sheet in the financial statements. It is important to be able to service all of the debt a

company owes compared to the amount of equity outstanding. It is imperative to maintain a good balance of debt to equity as well to be versatile in changing economic conditions. Times interest earned, Debt Service Margin, and the debt to equity ratio measure the credit risk to which a company is exposed, whether or not income from operations is able to cover interest charges, and the ability of the company’s cash from operations to cover the annual installment payments on the principals of the company’s long-term liabilities.

Debt to Equity

Debt to equity is computed by dividing a company’s total liabilities by its total owner’s equity. This ratio is a sign that there could be the possibility that interest and debt repayment cannot be fulfilled by the company’s cash flows. So companies should pay special attention to this ratio in order to stay away from potential credit risk. All of the industry seems to be in the range of .5 to 1.5 in the past five years. This keeps a pretty reasonable level of debt to equity. As the ratio goes above 1, there is more debt and below 1; more equity. Apache’s ratio has been the steadiest since 2002 at just under 1 showing Apache’s ability to balance their financing between debt and equity, keeping them both relatively steady.

Times Interest Earned

Times interest earned is calculated by dividing a company’s income from

operations by its interest expense. Before there can be any profits to the stockholders of a company, that company’s interest expense must be covered by income from operations. Time interest earned shows that for every dollar of interest expense a company has, they are producing that much more income from operations to cover the expense. The reason that XTO’s times interest earned ratio in 2005 is zero, is because they did not have an interest expense in that year, so the ratio could not be computed. Apache continues to lead the industry on average for times interest earned. Over the past five years, they have been the most consistent of the five studied competitors. Not only is Apache making more money for each dollar of interest expense, but they are the only company to have the dollars earned per dollar of interest expense increase each year since 2002.

Debt Service Margin

Debt to Service Margin

The debt service margin is an explanation of how well a company is able to cover their debt with the cash acquired from operations. The industry average is relatively low with the exception of XTO. Since 2003, most of the companies are at about the same debt to service margin which means that is the norm for the industry. Apache is in the industry norm area. One reason the industry average is so low is because many of these companies in the past 5 years or so have made large acquisitions and are having to pay them off. These acquisitions will most likely pay off in the future and the low debt to service margin is most likely temporary and should not be looked upon as strictly poor performance.

Conclusion

When looking over the capital structure graphs, Apache is in a pretty good state as compared to the rest of the oil and gas industry. They have maintained a good debt to equity ratio. Their times interest earned has been no less than stellar compared to the rest of the industry, and the debt to service margin is right along with most of their competitors.

IGR/SGR Analysis

IGR as well as SGR are important ratios because they tell investors valuable information about the growth of a company. The Internal Growth Rate, or IGR, is the amount of growth that the company can sustain internally without having to seek

outside financial assistance. On the other hand the Sustainable Growth Rate, or SGR, is the amount of growth a company can sustain without borrowing more money.

Internal Growth Rate

Apache’s IGR is much lower than the industry average IGR. This is an indicator that Apache has trouble financing projects with funds only generated within the

company. This shows that Apache is using outside sources to aid in their asset

acquisition as well as project undertakings. This could possibly be troublesome for the company, because a good balance between internal and external funding is favorable. Sustainable Growth Rate

Apache’s SGR is also much lower than the industry average SGR. This indicates that Apache is borrowing a lot of money to fund its asset acquisiton and projects. This is not favorable because in order for Apache to grow, they will have to borrow

significant funds to sustain their growth rate. Once Apache has finished its mass expansion and acquisitions, the SGR as well as the IGR should be more on target with the industry averages because they will be able to generate their own funds.

IGR/SGR

The IGR and SGR are important because they tell potential investors the limit to potential growth. After reaching this cap, the company cannot continue to grow without outside financial help. This is unattrative because they are not generating enough revenue within the company. Companies who increase debt to expand and grow, decrease their future profits because they have to repay that debt. A large IGR and SGR, unlike Apache’s, tells investors the company is set to do well in the future. In Apache’s case the low IGR and SGR are indicators the company is expanding and

acquiring more reserves. When the acquisitions of these reserves are complete, Apache will have higher IGR and SGR similar to that of the industry averages.