Northern Oil and Gas has been treading water for the past six months, recording a small return of 1.1% while holding steady at $28.25. The stock also fell short of the S&P 500’s 8.2% gain during that period.
Is now the time to buy Northern Oil and Gas, or should you be careful about including it in your portfolio? Check out our in-depth research report to see what our analysts have to say, it’s free.
Why is Northern Oil and Gas not exciting?
We’re passing on Northern Oil and Gas for now. Here are two reasons why there are better opportunities than NOG, plus one stock we’d rather own.
1. Shrinking EBITDA margin
Adjusted EBITDA margin is an important measure of profitability for the sector and accounts for the gross margins and operating costs mentioned previously. Unlike operating margin, it is not distorted by accounting conventions around reserves, drilling costs, and assumptions on commodity consumption from the well or basin. Adjusted EBITDA highlights the economic reality of how much cash the rock produces before the capital structure (debt service) and the drilling budget (capex) are considered.
Analyzing the trend in its profitability, Northern Oil and Gas’s EBITDA margin decreased by 22.9 percentage points over the last year. This raises questions about the company’s expense base because its revenue growth should have given it leverage on its fixed costs, resulting in better economies of scale and profitability. Its EBITDA margin for the trailing 12 months was 15.2%.
2. High debt levels increase risk
Debt is a tool that can boost company returns but presents risks if used irresponsibly. As long-term investors, we aim to avoid companies taking excessive advantage of this instrument because it could lead to insolvency.
Northern Oil and Gas’s $2.72 billion of debt exceeds the $47.6 million of cash on its balance sheet. Furthermore, its 8× net-debt-to-EBITDA ratio (based on its EBITDA of $331.5 million over the last 12 months) shows the company is overleveraged.
At this level of debt, incremental borrowing becomes increasingly expensive and credit agencies could downgrade the company’s rating if profitability falls. Northern Oil and Gas could also be backed into a corner if the market turns unexpectedly – a situation we seek to avoid as investors in high-quality companies.
We hope Northern Oil and Gas can improve its balance sheet and remain cautious until it increases its profitability or pays down its debt.
Final judgment
Northern Oil and Gas isn’t a terrible business, but it doesn’t pass our quality test. With its shares trailing the market in recent months, the stock trades at 5.6× forward P/E (or $28.25 per share). While this valuation is fair, the upside isn’t great compared to the potential downside. We’re fairly confident there are better investments elsewhere. Let us point you toward one of our top digital advertising picks.
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