Value Investing STEP Energy - The best value play in O&G (among many) |
| STEP Energy - The best value play in O&G (among many) Posted: 02 Oct 2018 10:40 PM PDT A quick summary of STEP and the industry: - Pressure pumper - Ridiculous valuation for mid-cycle (arguably early mid-cycle based on Canadian gas prices) - Has near term catalysts: o Continued rising WTI prices which should put upward pressure on dayrates in the US o Line 3 replacement is expected to be in service in H2 2019 which should close Canadian oil spreads somewhat o Cold winter which will raise AECO (Canadian natural gas prices) which are at historical lows. Winter has already begun in Alberta and we've seen spot prices and the near term curve come up substantially. - Long term catalysts o Keystone XL which should bring spreads back to historical levels for oil as there will be enough pipeline capacity o TransMountain twinning – you might hear argument whether this will ever go through. I have no doubt it will, but will be delayed. Frankly, delays don't matter because once Keystone XL is in place, Canada has enough pipeline capacity through 2026 or 2027 plus there will be a backlog of crude by rail available o LNG Canada – this was just announced this weekend. How this hasn't made the STEP stock move at all is mind boggling. Shell (one of their main customers) is a 42% owner of this project and this means Shell is going to pump up gas production, though admittedly not until 2022 and likely have a few acquisitions of Canadian Juniors on the way o Other LNG projects – much like roaches, you don't usually see a single terminal built - Best management (and most conservative) in the space. STEP started as a coil tubing co (which remains a meaningful portion of EBITDA) and has continually acquired assets at cyclical lows since. - Very low float which is likely a cause of the current share price drop relative to other pumpers. The public currently holds $100 million of the $367 million float. $220 million is held by the PE sponsor that took STEP public (however there isn't near term selling pressure as the funds aren't required to liquid in the short term). The remainder is held by institutions, and $3 million is held by insiders. The low inside ownership is likely the least attractive part of the thesis. STEP Energy is a Canadian pressure pumper (the company that does the actual fracking for all of the shale E&Ps) which has had its share price absolutely decimated for some very short term and transitory reasoning. O&G equities are largely underprices (Canadian pressure pumpers even more so), but STEP is by far the most underpriced with a ridiculous margin of safety. The pressure pumper space in Canada consists mainly of 3 companies, Trican, Calfrac, and STEP with some other smaller players as well. All three stocks have been absolutely destroyed over the past six months even though we've seen oil prices rising. The main reason, as far as I can tell, is while we've seen WTI skyrocketing to multi year highs, Canadian spreads have blown open for both heavy and light oil due to primarily egress issues (pipelines to move oil are currently overloaded), which has resulted in more limited capex budgets in Canada. This is exacerbated by capex budgets on gas drilling also decreased due to laughable AECO prices. Regardless, there's been some price pressure in the Canadian pressure pumping space specifically due to this (analyst note in early Sept which pushed the stock down even more) and Trican recently confirmed spot dayrates have seen pressure from another frac spread being brought into the spot market. My assumption is this is STEP's fracturing spread as they said in their Q2 call they would be putting their 9th spread to work when conditions warranted. So…apparently pricing is tightening but it's above breakeven for STEP to put another spread in as well. Regardless, this is all noise, because you end up getting the Canadian pressure pumping business for free. I'm just going to steal analyst estimates for US pressure pumping EBITDA, and coil tubing EBITDA because there has been no negative pricing pressure around any of these segments. In fact, coil tubing apprears even more in demand, and steel tariffs are likely creating a near term headwinds for anyone who wants to actually bring a new coil tubing spread online. 2018E: Canada Coil Tubing: $25-35 US Pumping: $55-70 US Coil Tubing: $40-$50 Total: $120-$155 STEP**, excluding its largest division**, trades at a 2018 EV/EBITDA between 4.2x and 5.2x. Canadian comps trade between 4.2x-6.8x 2018 EV/EBITDA. US comps trade around 2 turns higher. STEP has as good of a growth profile as any, along with the best management team in the space. I would call that a reasonable margin of safety. I'm not even going to put a target price on it, simply because the margin of safety is so absurd. The only actually risk is oil prices through fall the floor, which I don't see happening and am bullish on the oil picture. Natural gas prices in Canada are already in the basement, so there's no real risk there. Additionally, it's much cheaper to just…buy a pressure pumping company than to actually put together a frac spread right now, so I don't see ANY risk of the market getting oversupplied in regards to actual frac spreads. Otherwise, pricing is the name of the game as operating leverage is absolutely intense in this space. I would say the base case for this stock is a near term price target of $10 which would put EV/EBITDA in line with the Canadian comps. Realistically, it should trade near Calfrac as it is equally diversified. If we give a 20% liquidity discount, that would be a multiple of 5.4x. At 5.4x, with my 2018E EBITDA being $170, that would imply a price of $9.58. Bull case would put us as high as $25 if there is significant positive pricing pressure, which we very well could see if oil >$100 and the capital restraint producers are currently showing disappears. Misc other notes: - Debt isn't really a concern. Net debt/EBITDA is around 1.5x. My expectation is all cash flow will go to paying off debt. A buyback would be the best capital allocation decision at these levels (could literally buy back all the non PE sponsor equity with 2019 cash flow), but I don't think the PE sponsor took them public to immediately do a buyback. Maybe I'll be pleasantly surprised, but I doubt it. Trican is currently doing a significant buyback. - STEP is a top class operator with the highest margins and ROICs. Though, I find the ROICs to be slightly misleading as they bought during firesale assets, meaning their actual invested capital is lower. It's more a show of their capital allocation and market timing than actual operating prowess. - Maybe some people view this as bad because it implies consensus, but this is, across the board, viewed as a top pick/outperform by the analysts. Current target price is $13. I recently read a research report from an analyst with their bear case at $7, and base at $11. - Investor presentation is here: http://www.stepenergyservices.com/images/pdf/2018-09-STEP-Corporate-Presentation.pdf - I skipped a lot of more industry specific metrics (EV/HP) as well as specific customer discussion which can easily support the bull case. HP is important when reviewing the operating leverage of the business, and you can easily see where we can go from here based on pricing. - I didn't discuss the most recent merger with Tucker Energy Services (private before the acquisition) which is where they acquired the majority of their US assets. It was a tremendous deal for STEP as Tucker had a tremendous client base (including BP) that you rarely see from a private company. It was purchased at a very low multiple (somewhere between 4.0x and 4.5x) while the entire US space continued to trade two turns higher. - Demand drivers are unquestionably positive. Canada is slowly catching up to US frackers in terms of stages and proppant intensity. Obviously, this would be a gain for companies like STEP as it leads to additional time on site for the frac spreads. Thesis Summary The market is mispricing STEP even given the bear case scenario (absolutely no EBITDA contribution from Canada pressure pumping for the forseeable future) The market is GREATLY overestimating the near term headwinds which in dayrates for Canada which I only expect to affect Q3 2018 and to a lesser extent Q4 2018 (TCW still expects reasonably firm rates in Q1 2019, and STEP said in the Q2 conf call that they expect firmer rates in 2019 even though they are a conservative management team) The market is giving absolutely no credit to long term value drivers (one of which has already happened). Disclosure: Long STEP, probably will be longer in the near term [link] [comments]  |
| CapIQ - what is it good for over Bloomberg? Posted: 02 Oct 2018 09:32 PM PDT Hi, I was just given a CapIQ account at work. I already have a Bloomberg Terminal - is there anything CapIQ is good for over Bloomberg? [link] [comments]  |
| You are subscribed to email updates from Value Investing. To stop receiving these emails, you may unsubscribe now. | Email delivery powered by Google |
| Google, 1600 Amphitheatre Parkway, Mountain View, CA 94043, United States | |
No comments:
Post a Comment