These 4 Measures Indicate That Northern Oil and Gas (NYSE:NOG) Is Using Debt Reasonably Well

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Northern Oil and Gas, Inc. (NYSE:NOG) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Northern Oil and Gas

What Is Northern Oil and Gas's Debt?

The image below, which you can click on for greater detail, shows that at December 2023 Northern Oil and Gas had debt of US$1.84b, up from US$1.53b in one year. And it doesn't have much cash, so its net debt is about the same.

How Healthy Is Northern Oil and Gas' Balance Sheet?

We can see from the most recent balance sheet that Northern Oil and Gas had liabilities of US$385.8m falling due within a year, and liabilities of US$2.05b due beyond that. Offsetting this, it had US$8.20m in cash and US$373.8m in receivables that were due within 12 months. So its liabilities total US$2.05b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Northern Oil and Gas has a market capitalization of US$3.65b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

With net debt sitting at just 1.1 times EBITDA, Northern Oil and Gas is arguably pretty conservatively geared. And it boasts interest cover of 8.3 times, which is more than adequate. In addition to that, we're happy to report that Northern Oil and Gas has boosted its EBIT by 30%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Northern Oil and Gas can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Northern Oil and Gas burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Based on what we've seen Northern Oil and Gas is not finding it easy, given its conversion of EBIT to free cash flow, but the other factors we considered give us cause to be optimistic. In particular, we are dazzled with its EBIT growth rate. Looking at all this data makes us feel a little cautious about Northern Oil and Gas's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Be aware that Northern Oil and Gas is showing 5 warning signs in our investment analysis , and 2 of those are a bit unpleasant...

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.