C&J Energy Services (CJES) remains the cheapest stock in America. Eleven months ago, with the price sitting at $16.75 per share, I wrote an article making this claim. Today, not much has changed in my opinion with regards to value that lies within this company, even as the stock has appreciated by 20%.
Most of the oil services companies focused on domestic drilling are facing massive headwinds as the price of Natural Gas (UNG) has plummeted. Softness in Natural Gas prices has been well written about here on Seeking Alpha, so I will avoid repeating information that is widely available. What is important to consider though, in the face of the headwinds of this industry, is that investors are falling out of love with the sector. Any time investors begin to hate an investment, I begin to get interested.
Shorts Bet Big and Realize They Were Wrong
Below you can see the short interest in CJES since the writing of my first article. The headwinds of too much fracturing capacity mixed in with lower and lower Natty prices caused shorts to become emboldened and take a large bet against America's purest play on hydraulic fracturing, C&J Energy. On 1/31/2012, the price of CJES stood around $16.75 and the short interest in this stock stood at 6.8 million shares. The price of Natural Gas was collapsing, hydraulic fracturing margins were getting squeezed, and oil service stocks were getting crushed. Shorts were emboldened with what they assumed was a sure bet shorting CJES as they would begin to increase their position by over 105% through July of 2012. On July 31, with over 14 million shares shorted, the shorts had effectively shorted 40% of every share available in the float.
|Settlement Date||Short Interest||Avg Daily Share Volume||Days To Cover|
The only problem with this bearish strategy was the price of CJES continued to muscle slowly higher as the shorts got more and more "sure" they were right. I am dumbfounded as to what they were thinking at the time as it seems there were plenty of better options to short competitors that were not nearly as cheap as CJES.
CJES's 2012 PE at the time was 4.5 while the next closest competitor was 20% higher. RPC Inc. (RES) for example was trading at a PE ratio of 8.9 while the ROE for RES was 28% LOWER than CJES (64% vs 46%). So you had a better performing company, at a much cheaper price in CJES being priced 49% below the relative value of RPC. Huh?
Better Business Performance Than Peers
C&J Energy continues to baffle its critics with performance and efficiency that is second to none in the industry as C&J continues to offer the highest margins. Take a competitor like Patterson-UTI (PTEN) for example.
At the end of the third quarter, PTEN had 663,000 Horsepower in their hydraulic fracturing fleet and used this fleet to generate $182 million in fracturing revenue. That is $274.50 in revenue generated per horsepower for the quarter.
CJES had 265,000 Horsepower at the end of the quarter which generated $196 million in fracturing revenue. That is $739 in revenue per horsepower for the quarter, or 169% more than PTEN.
The outperformance does not stop there though. RPC Inc ended the quarter with 683,000 Horsepower which generated around $370 million in revenue. This is $541 of revenue per horsepower for the quarter, which is 27% LOWER than CJES.
Basic Energy Services (BAS) ended the quarter with 277,000 Horsepower in their fleet which brought in $143.3 million in revenue. This figure is $517 per horsepower and 30% below CJES.
These numbers are only beginning to scratch the surface on how much more efficient CJES is in regards to operating their business.
As guar prices began to skyrocket earlier this year, CJES began to see their competitive advantage shrink, although the numbers show they still had quite a distance gap in performance. David Anderson of JP Morgan stated:
While cross-linked gels with ceramics are preferred (better conductivity), they became costly (~$220-240k/stage in the Eagle Ford vs. ~$130-150k/stage for slick water) due to the run up in guar prices....
The shift towards slick water has actually weakened CJES's competitive advantage, making it more of a commodity due to lower engineering and fluid mgmt....
This pressure on CJES's business should now be dissipating though as the price of guar has come down considerably:
As the price of guar comes down, the outlook for CJES and their market beating margins increases substantially, as noted by JP Morgan:
CJES expects quick reversion back to cross-linked gels and ceramics as guar prices decline ahead of the new harvest season....
CJES's preference is cross-linked gels since they require greater
engineering and fluid management, which serves as a competitive advantage for CJES....
Despite Better Operational Performance, CJES Trades at a Huge Discount to Its Peers
One would think that a company growing as fast as CJES has been that is performing much better than the competition would be a company that trades at a premium to the market. One would be wrong in this case. CJES is trading at a huge discount per dollar of earnings than every company in the space.
Current 12 Month Trailing P/E of CJES = 5.44
Current 12 Month Trailing P/E of Competitors:
PTEN = 8.53
RES = 9.07
BAS = 7.34
The average trailing P/E of these three competitors is a 8.31. For CJES to be similarly valued as these peers, the price would need to be trading at $31.72 per share. With the price currently sitting at $20.75, CJES is undervalued on a relative basis by 52.8%.
Looking forward, the numbers are even more convincing. Industry analysts continue to reduce estimates for most domestic oil services companies as we head into 2013. Analysts for CJES expect earnings to drop by 12.78% next year while expecting revenues to INCREASE by 16.96%. This prices CJES at a forward P/E ratio of 6.83.
Many feel that contraction is the reason the stock price is trading so cheaply today. When we look at the competition though, CJES is still being priced much too cheaply:
PTEN earnings are estimated to decline 38.7% with revenues DECLINING 7.86%. This prices PTEN at a forward P/E ratio of 16.59.
RES earnings are estimated to decline 27.2% with revenues DECLINING 5.7%. This prices RES at a forward P/E ratio of 13.43.
BAS earnings are estimated to decline 70.4% with revenues DECLINING 2.9%. This prices BAS at a forward P/E ratio of 36.23.
Out of this group, CJES is the only company for which analysts expect to see revenue increase. The average drop in revenue for the peers is 5.48%, giving CJES a 22.44% advantage in expected revenue for 2013. The average earnings drop of its peers is an expected decline of 45.43% compared to an expected decline of only 12.78% for CJES. The average forward P/E ratio for the peers is 22.08, which is 223% greater than the 6.83 number for CJES.
Think about this.... CJES's competitors are expected to see their earnings slow 255% FASTER than CJES, see their revenues shrink in the face of increasing revenues for CJES, and yet, these companies are being given a value that is 223% greater than CJES. If I were to use the lowest forward P/E in the peer group of 13.43, CJES would be sporting a price per share today of $40.82 - almost 100% higher than where it trades today.
Despite Low Gas Prices, There is Plenty of Work Ahead
Regardless of whether the headwinds continue, CJES is still priced way too low on a relative basis against peers that are facing the same industry headwinds. These headwinds though will not last forever. The United States is about to embark on a new boom that will shock even the most bullish investor. With most countries needing Natural Gas and paying 3 to 10 times more than we do here in America, there is a huge opportunity to export massive amounts of gas in the form of Liquid Natural Gas. This is a few years away though, meaning we need to make sure there is another option for demand in the U.S. if the export market never becomes what most analysts believe it will.
That being said, CJES does a majority of its work in the Eagle Ford and Permian Basin area. While most E&P Producers are reining in their capital investment budgets, reports are that Eagle Ford will continue to see massive amounts of development taking place. Fuelfix.com just reported that $28 billion (27% of all capital spending for the oil and gas industry) will be invested in the Eagle Ford alone just next year. The numbers for the next few years are even more staggering. The article continues:
Between 2012 and 2015, the industry likely will sink more than $116 billion into the Eagle Ford - more than the cost of developing the Kashagan offshore field in Kazakhstan, which has been called the world's most expensive standalone energy project.
$116 billion is a lot of money, and that money is expected to be spent in the heart of where CJES operates as the premium company in the industry. No wonder they remain focused on increasing their Horsepower capacity at a time when competitors like RPC have stated they will stop adding new equipment. CJES knows they do a better job, and they see a massive amount of new work coming down the pipeline.
All of this massive amount of oil, cheap gas, and cheap liquids is going to create massive amounts of demand from companies around the world looking to get their hands on this cheap energy. For example, Santana Textiles, a Brazilian denim manufacturer, recently completed development of a 33-acre facility in Edinburg, Texas. The new plant will house the company's spinning and weaving operations and storage warehouses, along with its 800 employees. The Edinburg facility is Santana Textiles' largest, and will produce high quality denim lines for fashion designers. Source: PRNewsWire
When is the last time America GAINED manufacturing jobs from an emerging country? This is revolutionary. This is going to be a game changer for America.
It doesn't end there.
WHAM-O is moving Frisbee production from China of all places back to the U.S. - Source
Again, when is the last time a company moved manufacturing to America from China? It has been the opposite for decades.
The Wall Street Journal recently reported a French company is building a new $650 million steel plant in Youngstown, OH. I thought that was only going on in China?
An Egyptian fertilizer company is building a $1.4 billion plant in Iowa. The CEO of this company reiterates what I am seeing when he says:
Increasing U.S. natural gas reserves and growing demand for fertilizers have been "game changers," Sawiris said, making the project "a very attractive investment."
Chemical companies don't want to be left out of the Natural Gas Game Changer that lies ahead. Chemical makers are vying to build the first new U.S. ethylene plants, known as crackers, since 2001.
Dow Chemical (DOW) just applied for a federal permit to build the company's biggest ethylene plant as cheap natural gas gives manufacturers a cost advantage. Ethylene is used in the production of just about every product you can imagine. The proposed plant would produce 1.5 million tons of Ethylene per year, which is the same size as Texas ethylene plants proposed by Chevron Phillips Chemical Co. and Exxon Mobil Corp. (XOM) and it would be Dow's largest in the world.
Formosa Plastics Corp. USA is citing new natural gas supplies as a reason for a massive $1.7 billion expansion of its plastics and petrochemicals site in Point Comfort, Texas. Westlake Chemical Corp. and Nova also are increasing ethylene capacity at existing locations.
LyondellBasell Industries, and Eastman Chemical (NYSE:EMN) have also announced plans to either build or reopen new energy and chemical plants in the U.S.
These companies will usher in other manufacturers who want to buy their plastics and chemicals for their own manufacturing at much lower prices. This is all being made possible because of the technology of hydraulic fracturing opening up vast amounts of cheap resources here in America, and CJES is at the heart of where this is all taking place. Not only are they at the heart of the boom, they happen to be the best performing and cheapest stock in the space. My target for CJES remains over $40 per share. It is a fast growing small cap stock in a growth industry trading as a deep value play at the moment.
Additional disclosure: CJES is our clients' largest holding in general, and my largest holding personally.