Northern Oil and Gas Fixed Income Bonds, Over 22% Yield-to-Maturity, Maturing June 2020
This week, Durig Fixed Income 2 (FX2) takes a third look at Northern Oil and Gas (NYSE:NOG), a non-operator whose focus is in the lucrative Williston Basin in North Dakota and Montana. Since our last review of Northern in October of 2016, the company has been building momentum, especially over the past few quarters, and has also recently released its Q3 financial results.
- Northern showed both sequential and year-over-year production increases of 11% and 14%, respectively.
- Revenues for the nine months ending September 30, 2017 increased by 59.1% over the same period in 2016.
- In early November, NOG entered into a 5-year agreement with TPG Partners for a $400 million credit facility. This has provided much increased liquidity and delayed debt maturities.
Oil’s recovery provides investment opportunities for those who seek companies who are not just surviving, but who look to build a better and leaner organization. Northern Oil and Gas is one such company. These 30-month bonds, couponed at 8.0% with a yield-to-maturity of over 22%, are an ideal addition to an already diversified portfolio, and have met our criteria for additional weighting in our FX2 managed income portfolios, the most recent aggregated and benchmarked performance of which is displayed below.
Northern Oil and Gas recently released its Q3 and year-to-date results. The company looks to be building momentum, especially as prices of West Texas Intermediate oil continue to appreciate. Highlights for NOG for the three and nine months ending September 30, 2017 include:
- Daily production increased 11% sequentially, over Q2 levels.
- Production also registered a 14% increase over Q3 2016 levels.
- Total revenues for the nine months ending September 30, 2017 increased 58.1%, from $109.0 million to $172.3 million.
- Adjusted EBITDA grew from $33.0 million in Q3 2016, to $35.7 million in Q3 2017, an increase of 8.2%.
- NOG had operating income of $585,000, even with a $12.7 million loss on derivative instruments for the quarter.
In addition to these excellent results, on November 1, 2017, Northern Oil and Gas secured a new five-year agreement with TPG for a new $400 million first lien credit facility. This new credit facility greatly increases the company’s available liquidity and extends its debt maturities (NOG’s former bank credit facility with Royal Bank of Canada was due to mature in September 2018).
About the Issuer
Northern Oil and Gas is an independent energy company engaged in the acquisition, exploration, exploitation, development and production of crude oil and natural gas properties. Northern’s principal business is crude oil and natural gas exploration, development, and production with operations in North Dakota and Montana that primarily target the Bakken and Three Forks formations in the Williston Basin of the United States. The Company acquires leasehold interests that comprise of non-operated working interests in wells and in drilling projects within its area of operations. As of September 30, 2017, Northern leased approximately 145,749 net acres, of which 100% were located in the Williston Basin of North Dakota and Montana.
The Non-Operator Advantage
While most exploration and production companies are directly involved in exploration and production (they search for new places to drill and are actually responsible for the drilling and extracting of oil from new wells), NOG is a non-operator, meaning they do not drill or operate wells. Instead, they own a minority working interest in the properties where the wells are located. One of the benefits of a non-operator include the ability to pick and choose the most lucrative wells (“cherry-pick”) with the highest rates of return, only allocating capital to wells that will maximize profits. In addition, being a non-operator gives NOG the ability to control a large acreage position, substantial production profile and high quality reserves with a very small number of employees.
With the reporting of its Q3 results along with other recent developments, NOG does appear to be building momentum throughout the course of 2017. Like many oil companies, NOG was forced to reduce its capital expenditures over the past three years due to significant decreases in the prices of oil and gas. However, NOG has managed to keep production relatively steady while spending much less capital. This scenario of maintaining relatively steady production while reducing or keeping capital spending low is similar to our August 2017 review of WTI Offshore, “Drill into 25%+ YTM with W&T Offshore Fixed Income, June 2019 Bonds”
(Source: NOG Q3 Presentation)
In addition, the company has registered increases in adjusted EBITDA in each successive quarter for 2017, as shown below.
Jones Energy Holdings, another oil exploration and production company has also been “doing more with less” and is discussed in our September 2017 review “Earn ~16% YTM with Jones Energy Holdings, Fixed Income Bond, Maturing April 2022”. Lastly, Northern has continued to have excellent internal rates of return (IRR) on its wells, with current IRRs at 35%. Shown below is a slide from the company’s most recent earnings call presentation.
WTI’s Recent Increases
In recent months, the price of WTI has been trending upwards, flirting with the $60 / barrel mark earlier in November. While no one can accurately predict the future price movement of oil, there are a few developments that could contribute to continued price increases.
(WTI Prices – June-November 2017. Source – Macrotrends.net)
First, markets are carefully watching the OPEC producers, who (at the time of the writing of this article) are meeting to discuss extending their agreement to curtail production. The current consensus is that members will agree on an extension to the production cuts but the duration of the extension is uncertain. Second, reserve levels are decreasing. U.S. commercial crude inventories have fallen by more than 15 percent from their March record to 453.7 million barrels, below levels at this time in 2015 and 2016, although they remain above 5-year average levels.
Interest Coverage and Liquidity
Interest coverage is of paramount importance to bondholders as it indicates a company’s ability to service its existing debt load. For the nine months ending September 30, 2017, NOG registered operating income of $64.2 million with interest expense of $49.4 million for interest coverage of 1.3x. Although this is lower than some of the other issuers we’ve profiled, NOG does appear to be picking up momentum.
Since NOG recently entered into a new five-year senior secured credit facility, the company has access to a cash that can be used for its liquidity purposes. As of November 1, 2017, NOG has total liquidity of $135 million comprised of $35 million in cash and $100 million from its revolving credit facility.
The risk to bondholders is whether Northern Oil can continue to build on the momentum it has generated over the past three quarters. The company has seen healthy increases in production in Q3 and its adjusted EBITDA has steadily increased in each quarter of 2017. The new credit facility with TPG is encouraging as well, since banks often are not keen to lend to companies whose survival might be in question. In addition, the recent increase in oil prices has the whole industry buzzing. WTI prices could possible reach $60 by year-end, which would also be of significant benefit to Northern. Given these factors, it does appear that the over 22% yield-to-maturity on NOG’s 2020 bonds outweighs the risks identified.
The majority of NOG’s revenues are affected by the price of oil. Since oil hit its recent low in early 2016, it has continued to jockey between $40 and $58 per barrel. Most agree that oil prices will recover, but the pace of that ultimate recovery is still in question. If oil prices were to experience another significant and prolonged decrease, it could affect NOG’s revenues and profitability.
In general, bond prices rise when interest rates fall and vice versa. This effect tends to be more pronounced for lower couponed, longer-term debt instruments. Any fixed income security sold or redeemed prior to maturity may be subject to a gain or loss. Higher yielding bonds typically have lower credit ratings, if any, and therefore involve higher degrees of risk and may not be suitable for all investors.
Summary and Conclusion
Northern Oil and Gas continues to advantageously use its non-operator status, singling out the most lucrative wells to participate in, thereby making wise use of its reduced capital spending budget. The company is building momentum – increasing revenues, production, and adjusted EBITDA. In addition, its recent agreement with TPG has provided increased liquidity and moved out debt maturities, effectively buying time for the company as it continues making progress on its key initiatives. The company’s 30-month bonds currently have an outstanding yield-to-maturity of about 22% and are an excellent choice for increased weighting in our FX2 managed income portfolio, the most recent aggregate performance of which is shown above.
Issuer: Northern Oil and Gas
Ratings: Caa3 / CCC+
Yield to Maturity: ~22.175%
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Disclosure: Durig and certain clients may have positions in Northern Oil & Gas 2020 bonds. To receive updates on NOG 2020 bonds, please sign up for our Free Bond Newsletter.
Please note that all yield and price indications are shown from the time of our research. Our reports are never an offer to buy or sell any security. We are not a broker/dealer, and reports are intended for distribution to our clients. As a result of our institutional association, we frequently obtain better yield/price executions for our clients than is initially indicated in our reports. We welcome inquiries from other advisors that may also be interested in our work and the possibilities of achieving higher yields for retail clients.
Durig Capital Fixed Income 2 (FX2) Mid-Month Portfolio Review
The relatively standard benchmarks shown below are compared to the Year-to-Date (YTD) and Trailing 1 year returns provided by the High-Yield Bond Mutual Fund database provided by Morningstar. We estimate that Morningstar tracks the performance of and benchmarks close to 800 High-Yielding Bond Mutual Funds, and on December 19th, 2017, this is how our clients aggregated FX2 portfolios compared to Morningstar’s high-yield bond fund database:
Year-to-Date, FX2 returns were up 15.71%, and outperformed every high-yield bond mutual fund that was listed. The top five performing high-yield bond funds we identified on Morningstar in Year-to-Date return were:
- Fidelity Capital & Income (FAGIX), 11.28%
- Fidelity Advisor High Income Advantage I (FAHCX), 11.15%
- Fidelity Advisor High Income Advantage A (FAHDX), 10.84%
- Fidelity Advisor High Income Advantage M (FAHYX), 10.80%
- Diamond Hill High Yield Y (DHHYX), 10.18%
- The average YTD return among the high-yield bond mutual funds listed was 6.17%
- FX2 aggregated year-to-date returns were 154.62% above the average YTD return of the high-yield bond mutual funds listed
Trailing 1 Year
For a Trailing 1 Year period, FX2 returns were up 16.10%, and outperformed every high-yield bond mutual fund that was listed. The top five performing high-yield bond funds we identified on Morningstar in Trailing 1 Year return were:
- Fidelity Capital & Income (FAGIX), 11.74%
- Fidelity Advisor High Income Advantage I (FAHCX), 11.46%
- Fidelity Advisor High Income Advantage A (FAHDX), 11.26%
- Fidelity Advisor High Income Advantage M (FAHYX), 11.23%
- Pioneer Global High Yield Y (GHYYX), 10.78%
- The average Trailing 1 Year return among the high-yield bond mutual funds listed was 6.74%
- FX2 aggregated Trailing 1 Year returns were 138.87% above the average Trailing 1 Year of the high-yield bond mutual funds listed
Past performance is no guarantee of future results. FX2 is a composite of individual (segregated) bond accounts comprised of individual bond positions, with return averages both higher and lower than the FX2 composite returns. Individual (segregated) accounts are a different investment vehicle than bond funds, offering more easily customized asset allocation and tax accountability compared to having all the investments held in one single large pool. To learn more, call us toll-free at: (877) 359-5319 or find us at: Durig Fixed Income 2
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