Northern Oil and Gas Adds To Its Permian Position (NOG)

Northern Oil and Gas (NYSE:NOG) continues to grow through acquisitions, this time paying $110 million to Laredo Petroleum (LPI) for non-operated (mostly operated by SM Energy (SM)) working assets in the Midland Basin (Howard County). This acquisition combined with Northern’s spending on preferred and common share repurchases will likely result in its net debt exceeding $1 billion at the end of 2022. However, Northern’s balance sheet should still be relatively healthy with leverage projected at 0.9x at the end of 2022.

At $32 per share, Northern appears to be a better value now compared to when I looked at it a few months ago. Northern has improved its estimated value a bit through its share repurchases and I now believe it could be worth $38 per share in a scenario where prices follow current strip until the end of 2023 and then average around $75 WTI oil and $3.75 NYMEX gas after that point.

Acquisition Details

Northern is paying $110 million in cash to Laredo Petroleum. The effective date of the transaction is August 1, 2022 and the expected closing date is in October 2022.

The acquired assets are expected to average over 1,800 BOEPD (86% oil) in production during the next 12 months, based on two-stream reporting. There are 9.6 net undeveloped and in-process locations in the approximately 1,600 net acres.

Northern expects $48 million in forward-year (from the expected October closing date) unhedged cash flow from operations at mid-August strip prices. Maintenance capex is expected to be around $15 million per year to keep production steady.

One thing to note is that Laredo indicated that its divested assets were expected to average approximately 1,800 BOEPD (72% oil) in production during 2023.

Laredo reports production on a three-stream basis, which results in higher reported total production numbers than two-stream reporting. The oil production numbers (in barrels per day) do not change between two and three-stream reporting though. Northern’s expectations for forward-year oil production is around 20% higher than what Laredo mentioned for 2023 oil production.

The reason for the difference appears to be that there are 1.6 net in-process wells that are likely to come online in Q4 2022. This will significantly boost Q4 2022 production numbers, which are included in Northern’s production estimates, but not in Laredo’s.

Acquisition Value

The $110 million purchase price appears to be fair to me. This is only 2.3x forward-year cash flow from operations, but that multiple is lowered by relatively high near-term commodity prices along with the boost in production from the completion of the wells-in-process. The acquired assets are also relatively developed, with the remaining 8 net inventory locations translating into around five to six years of inventory (while attempting to maintain production levels).

At a longer-term oil price (my assumption) of $75 WTI oil, the acquired assets could generate around $37 million per year in cash flow from operations if production in maintained. This would result in around $22 million per year in asset-level free cash flow.

Thus the $110 million purchase price would be around 3.0x cash flow from operations at $75 WTI oil, while the free cash flow yield (excluding interest costs on the credit facility debt used in the purchase) would be 20%. These metrics appears reasonable for the current market as well as the amount of inventory included in the assets. At current strip prices (and maintenance capex), the cash flow from the assets should pay off the purchase price in around four to five years.

Debt And Valuation

Northern has been active in repurchasing its shares (both preferred and common). It repurchased 575,000 shares of its 6.5% convertible preferred stock for $81.2 million in 1H 2022. It also (up to the end of July) had repurchased 0.76 million common shares for $20 million.

Northern’s various acquisitions and share repurchases will result in it having more net debt (in total dollars) at the end of 2022 compared to the end of 2021. It ended 2021 with $795 million in net debt and I now project it to end 2022 with $1.02 billion in net debt, not including the effect of further share repurchases. Northern’s leverage should end up at a reasonable level though, as I project its year-end 2022 leverage to be 0.9x.

The share repurchases have helped reduce Northern’s share count (assuming conversion of the preferred shares and exercise of the warrants) to approximately 88.2 million.

I estimate Northern’s value at approximately $38 per share in a scenario where oil and gas prices follow current strip until the end of 2023, and then revert to an average of $75 WTI oil and $3.75 NYMEX gas after that point.

Conclusion

Northern’s latest Midland Basin acquisition appears to be at a reasonable price. Northern is now projected to end 2022 with approximately $1.02 billion in net debt, but its leverage remains a reasonable 0.9x since its production has been increasing substantially due to all its acquisitions.

Northern has also been reducing its share count through repurchases (both of preferred and common stock) and has spent over $100 million on share repurchases in 2022 (up to the end of July).

At $32 per share, Northern appears to have decent upside in a long-term (after 2022) $75 WTI oil scenario.