The past six months have been a windfall for Kosmos Energy’s shareholders. The company’s stock price has jumped 171%, hitting $2.49 per share. This performance may have investors wondering how to approach the situation.
Is there a buying opportunity in Kosmos Energy, or does it present a risk to your portfolio? See what our analysts have to say in our full research report, it’s free.
Why Is Kosmos Energy Not Exciting?
Despite the momentum, we’re swiping left on Kosmos Energy for now. Here are three reasons you should be careful with KOS, plus one stock we’d rather own.
1. Fewer Distribution Channels Limit Its Ceiling
The scale of a company’s revenue base is an important lens through which to view the topline, as it signals whether a producer has gone from a vulnerable commodity taker into a durable operating platform. Larger producers generate revenue across many wells, pads, takeaway routes, and geographies rather than relying on a single field or drilling program.
Kosmos Energy’s $1.37 billion of revenue in the last year is pretty small for the industry, suggesting the company is a subscale business in an industry where scale matters.
2. Shrinking EBITDA Margin
Adjusted EBITDA margin is an important measure of profitability for the sector and accounts for the gross margins and operating costs mentioned previously. Unlike operating margin, it is not distorted by accounting conventions around reserves, drilling costs, and assumptions on commodity consumption from the well or basin. Adjusted EBITDA highlights the economic reality of how much cash the rock produces before the capital structure (debt service) and the drilling budget (capex) are considered.
Analyzing the trend in its profitability, Kosmos Energy’s EBITDA margin decreased by 11.9 percentage points over the last year. This raises questions about the company’s expense base because its revenue growth should have given it leverage on its fixed costs, resulting in better economies of scale and profitability. Its EBITDA margin for the trailing 12 months was 45.8%.
3. Cash Burn Ignites Concerns
Free cash flow isn’t a prominently featured metric in company financials and earnings releases, but we think it’s telling because it accounts for all operating and capital expenses, making it tough to manipulate. Cash is king.
While Kosmos Energy posted positive free cash flow this quarter, the broader story hasn’t been so clean. Kosmos Energy’s demanding reinvestments have drained its resources over the last five years, putting it in a pinch and limiting its ability to return capital to investors. Its free cash flow margin averaged negative 7.5%, meaning it lit $7.45 of cash on fire for every $100 in revenue.
Final Judgment
Kosmos Energy’s business quality ultimately falls short of our standards. Following the recent rally, the stock trades at 7.2× forward P/E (or $2.49 per share). While this valuation is optically cheap, the potential downside is big given its shaky fundamentals. We’re pretty confident there are more exciting stocks to buy at the moment. Let us point you toward an all-weather company that owns household favorite Taco Bell.
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