Northern Oil and Gas trades at $24.07 per share and has stayed right on track with the overall market, gaining 8.6% over the last six months. At the same time, the S&P 500 has returned 7.7%.
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Why Is Northern Oil and Gas Not Exciting?
We're cautious about Northern Oil and Gas. Here are two reasons we avoid NOG and a 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.
Looking at the trend in its profitability, Northern Oil and Gas’s EBITDA margin decreased by 3.2 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 7.5%.
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 $2.55 billion of debt exceeds the $37.04 million of cash on its balance sheet. Furthermore, its 15× net-debt-to-EBITDA ratio (based on its EBITDA of $167.9 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. That said, the stock currently trades at 6.6× forward P/E (or $24.07 per share). This valuation is reasonable, but the company’s shakier fundamentals present too much downside risk. We're pretty confident there are superior stocks to buy right now. Let us point you toward one of Charlie Munger’s all-time favorite businesses.
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