As part of my recent trip to Houston, Texas, I had the opportunity to sit down with Robert Workman, CEO of Now Inc. (NYSE:DNOW). The company, spun off from oilfield equipment manufacturer National Oilwell Varco (NYSE:NOV) in spring 2014, acts as the supplier of over 30,000 parts and equipment to the global energy and gas industry. Sounds like a scary business to be in these days, right? Wrong. In the brief time I spent with Workman, I was surprised to learn that not only was he and his team not sweating the current downturn, they were in the process of taking advantage of it in two specific ways.
Expanding the empire
Distribution can be a mind-numbing, low-margin business saddled with high inventories, low cash balances, and even lower profit margins. Talking to Workman, however, one would not get this impression. Granted, the company did sport an EBITDA margin of 4.5% last year and an inventory balance of $892 million (36%) out of an entire asset base of $2.47 billion as of June 30, 2015. The basic fundamentals of the parts distribution business aside, Workman could not be more excited about the future of his company.
Until May 2014, DNOW was a part of the vast organization that is National Oilwell Varco. National Oilwell's primary business of manufacturing consistently boasted considerably larger profit margins than those of a high-volume, low-profit distributor. DNOW was a cash cow for National Oilwell, but when it came time to make acquisitions and expand either company's territory, it was hard to compete with National Oilwell's other businesses. That has changed.
The current downturn in energy prices obviously hasn't been ideal for any business with ties to the broad oil and gas sector, but for an acquisitive company like DNOW, equipped with its newfound freedom, the timing couldn't be better. Workman and his team have made two sizable acquisitions in the last year and a half -- funded through working capital and cost reductions, no less -- and plan to do much more if they get their way.
The best defense is a good offense
As most readers are no doubt aware, four years of $100-plus oil prices has led to a good bit of leverage. Not so at DNOW. As of June 30, the company boasts a debt-to-assets ratio of just 22.8% -- the majority of which is merely short-term accounts payable. That's going to change if Workman is able to fully realize his vision. DNOW is constantly on the lookout for acquisition candidates: companies that can be P&L-additive as well as bring new product offerings to DNOW's immense distribution network. Should the right string of acquisition candidates be identified, it would not be inconceivable for DNOW to expand its current leverage. The current downturn has depressed sale prices and asset values, and if an acquisition makes sense today, it will no doubt make even more sense in the inevitable turnaround. This tactic makes all the more sense if the acquisition is currently profitable, in the worst industry downturn in recent memory, and funded with the low-cost debt available today. Talk about going on offense at a time when the industry, at large, is playing defense.
It might very well be coincidence that Robert Workman and his team at DNOW find themselves conservatively financed and primed to make acquisitions during an industrywide downturn. I, for one, am not so sure. The DNA that has been instilled in the entire DNOW organization by National Oilwell Varco -- a philosophy of prudence, digging in and doing what makes sense -- suggests to me that there's something more than luck going on here. Look out, energy investors: This is one company that's making all the right moves.
Sean O'Reilly has no position in any stocks mentioned. The Motley Fool owns shares of and recommends National Oilwell Varco and Now. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.