Northern Oil And Gas: Inside The Numbers

Dec.28.12 | About: Northern Oil (NOG)

Determining a company's financial health is a very important step in making a decision on whether or not to invest or to stay invested. There are many different ways to compute a company's financial health. In this test, I will be considering Northern Oil & Gas Inc.'s (NYSEMKT:NOG) profitability, debt and capital, and operating efficiency. Based on these criteria, we get to see sales, returns, margins, liabilities, assets, returns and turnovers.

All numbers sourced from Morningstar and company website.

Profitability

Profitability is a class of financial metrics used to assess a business' ability to generate earnings compared with expenses and other relevant costs incurred during a specific period of time. In this section, we will look at four tests of profitability. They are: Net Income, Operating Cash Flow, Return on Assets, and Quality of Earnings. From these four metrics, we will establish if the company is making money, and gauge the quality of the reported profits.

  • Net Income 2010 = $7 million
  • Net Income 2011 = $41 million
  • Net Income 2012 TTM = $51 million

To pass, the company needs to have a positive net income. Northern Oil and Gas passes. So far in 2012, the company reported a net income of $51 million.

  • Operating Cash Flow 2010 = $12 million
  • Operating Cash Flow 2011 = $67 million
  • Operating Cash Flow 2012 TTM = $87 million

Operating Cash Flow is the cash generated from the operations of a company, generally defined as revenue less all operating expenses, but calculated through a series of adjustments to net income.

To pass, the company needs to have a positive operating cash flow. NOG passes.

ROA -- Return On Assets = Net Income/Total Assets

ROA is an indicator of how profitable a company is relative to its total assets. ROA gives an idea as to how efficient management is at using its assets to generate earnings. Calculated by dividing a company's net income by its total assets, ROA is displayed as a percentage. Sometimes this is referred to as "return on investment."

  • Net income growth

    • Net Income 2010 = $7 million
    • Net Income 2011 = $41 million
    • Net Income 2012 TTM = $51 million
  • Total Asset growth

    • Total Assets 2010 = $510 million
    • Total Assets 2011 = $726 million
    • Total Assets 2012 TTM = $1.135 billion
  • ROA -- Return On Assets

    • Return On Assets 2010 = 1.37%
    • Return On Assets 2011 = 5.65%
    • Return On Assets 2012 TTM = 4.49%

Over the past three years, NOG's ROA has increased from 1.37% in 2010 to 4.49% in 2012 TTM. This indicates the company is making money on its assets. As the ROA has increased, NOG passes.

Quality Of Earnings

Quality of Earnings is the amount of earnings attributable to higher sales or lower costs rather than artificial profits created by accounting anomalies such as inflation of inventory. To ensure there are no artificial profits being processed, the operating cash flow must exceed the net income.

2010

  • Operating Cash Flow 2010 = $12 million
  • Net Income 2010 = $7 million

2011

  • Operating Cash Flow 2011 = $67 million
  • Net Income 2011 = $41 million

2012 TTM

  • Operating Cash Flow 2012 TTM = $87 million
  • Net Income 2012 TTM = $51 million

Over the past three years, the operating cash flow has been higher than the net income. This indicates that the company is not artificially creating profits by accounting anomalies such as inflation of inventory. As operating cash flow exceeds net income all three years, NOG passes.

Debt And Capital

The Debt and Capital section establishes if the company is sinking into debt or digging its way out. It will also determine if the company is growing organically or raising cash by selling off stock.

Total Liabilities To Total Assets, Or TL/A ratio

TL/A ratio is a metric used to measure a company's financial risk by determining how much of the company's assets have been financed by debt.

  • Total Assets

    • Total Assets 2010 = $510 million
    • Total Assets 2011 = $726 million
    • Total Assets 2012 TTM = $1.135 billion
    • Equals an increase of 122.55%
  • Total Liabilities

    • Total Liabilities 2010 = $74 million
    • Total Liabilities 2011 = $229 million
    • Total Liabilities 2012 TTM = $570 million
    • Equals an decrease of 670.27%

Over the past three years, NOG's increase in total assets was less than the percentage increase of total liabilities. This indicates that the company has been financing its assets through debt. Over the past three years, the company's total assets increased by 122.55%, while the total liabilities increased by 670.27%. As the total assets did not increased more than the total liabilities, NOG does not pass.

Working Capital

Working Capital is a general and quick measure of liquidity of a firm. It represents the margin of safety or cushion available to the creditors. It is an index of the firm's financial stability. It is also an index of technical solvency and an index of the strength of working capital.

Current Ratio = Current Assets/Current liabilities

  • Current Assets

    • Current Assets 2010 = $233 million
    • Current Assets 2011 = $81 million
    • Current Assets 2012 TTM = $97 million
  • Current liabilities

    • Current liabilities 2010 = $60 million
    • Current liabilities 2011 = $120 million
    • Current liabilities 2012 TTM = $135 million
  • Current Ratio 2010 = 3.88
  • Current Ratio 2011 = 0.68
  • Current Ratio 2012 TTM = 0.72

Over the past three years, NOG's current ratio has decreased from 3.88 in 2010 to 0.72 in 2012. This indicates that the company has less of the ability to pay off its short-term obligations than it did three years ago. As the number is below 1, this indicates that the company would not be able to pay off its obligations if they came due at this point.

As Northern Oil & Gas's current ratio has decreased over the past three years, NOG does not pass.

Shares Outstanding

  • 2010 Shares Outstanding = 51 billion
  • 2011 Shares Outstanding = 62 billion
  • 2012 Shares Outstanding = 63.48 billion

To pass, the company's shares must increase less than by 2% in any one-year segment. Between 2010 and 2011, the company's shares increased by 21.57%, while between 2011 and 2012, the company's shares increased by 2.38%. As the company's shares have increased by more than 2%, NOG does not pass.

Operating Efficiency

Operating Efficiency is a market condition that exists when participants can execute transactions and receive services at a price that equates fairly to the actual costs required to provide them. An operationally efficient market allows investors to make transactions that move the market further toward the overall goal of prudent capital allocation without being chiseled down by excessive frictional costs, which would reduce the risk/reward profile of the transaction.

Gross Margin: Gross Income/Sales

The gross profit margin is a measurement of a company's manufacturing and distribution efficiency during the production process. The gross profit tells an investor the percentage of revenue/sales left after subtracting the cost of goods sold. A company that boasts a higher gross profit margin than its competitors and industry is more efficient. Investors tend to pay more for businesses that have higher efficiency ratings than their competitors, as these businesses should be able to make a decent profit as long as overhead costs are controlled (overhead refers to rent, utilities, etc.).

  • Gross Margin 2010 = $36 million / $45 million = 80.00%
  • Gross Margin 2011 = $122 million / $149 million = 81.88%
  • Gross Margin 2012 TTM = $205 million / $257 million = 79.77%

Over the past three years, the gross margin has decreased from 80.00% to 79.77%. As the margin has decreased, this indicates the company has been less efficient in its distribution. As the gross margin decreased by less than 0.25%, this is a moot point.

Asset Turnover

The formula for the asset turnover ratio evaluates how well a company is utilizing its assets to produce revenue. The numerator of the asset turnover ratio formula shows revenues found on a company's income statement and the denominator shows total assets, which are found on a company's balance sheet. Total assets should be averaged over the period of time that is being evaluated.

  • Revenue growth

    • Revenue 2010 = $45 million
    • Revenue 2011 = $149 million
    • Revenue 2012 TTM = $257 million
    • Equals an increase of 471.11%
  • Total Asset growth

    • Total Assets 2010 = $510 million
    • Total Assets 2011 = $726 million
    • Total Assets 2012 TTM = $1.135 billion
    • Equals an increase of 122.55%

As the revenue growth has exceeded the asset growth, this implies that the company has been producing revenue on its assets. NOG passes.

Based on the nine tests that Northern Oil and Gas received on profitability, debt and capital, and operating efficiency, the company achieved five passes and a moot point out of nine. This is a good grade for financial health. Northern Oil and Gas did not pass the debt and capital aspects of the paper. As the company is growing, it is increasing its debt. This is not necessarily a bad thing, but it is an aspect of the company to be aware of and keep an eye on moving forward.

Looking forward, analysts at MSN money have estimated that NOG will post an EPS of $1.00 for FY 2012 and $1.27 for FY 2013. Overall, the company is showing good results regarding its financial health with five passes and a moot point out of nine.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.