MDU Resources has had an impressive run over the past six months as its shares have beaten the S&P 500 by 9.3%. The stock now trades at $19.72, marking a 19.4% gain. This performance may have investors wondering how to approach the situation.
Is now the time to buy MDU Resources, or should you be careful about including it in your portfolio? Get the full stock story straight from our expert analysts, it’s free for active Edge members.
Why Do We Think MDU Resources Will Underperform?
We’re happy investors have made money, but we're swiping left on MDU Resources for now. Here are three reasons why MDU doesn't excite us and a stock we'd rather own.
1. Revenue Spiraling Downwards
A company’s long-term sales performance can indicate its overall quality. Any business can put up a good quarter or two, but many enduring ones grow for years. MDU Resources struggled to consistently generate demand over the last five years as its sales dropped at a 15.3% annual rate. This wasn’t a great result and is a sign of poor business quality.
2. Breakeven Free Cash Flow Limits Reinvestment Potential
If you’ve followed StockStory for a while, you know we emphasize free cash flow. Why, you ask? We believe that in the end, cash is king, and you can’t use accounting profits to pay the bills.
MDU Resources broke even from a free cash flow perspective over the last five years, giving the company limited opportunities to return capital to shareholders. The divergence from its good operating margin stems from its capital-intensive business model, which requires MDU Resources to make large cash investments in working capital and capital expenditures.
3. 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.
MDU Resources’s $2.19 billion of debt exceeds the $75.85 million of cash on its balance sheet. Furthermore, its 7× net-debt-to-EBITDA ratio (based on its EBITDA of $324.8 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. MDU Resources 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 MDU Resources can improve its balance sheet and remain cautious until it increases its profitability or pays down its debt.
Final Judgment
MDU Resources doesn’t pass our quality test. With its shares outperforming the market lately, the stock trades at 19.7× forward P/E (or $19.72 per share). At this valuation, there’s a lot of good news priced in - we think there are better stocks to buy right now. We’d recommend looking at one of our all-time favorite software stocks.
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