Seeking Alpha
Newsletter provider, deep value, long/short equity, commodities
Profile| Send Message|
( followers)  

Introduction

Crude oil prices have traded in a band between about $85 per barrel on the low side and approaching $100 on the high side. Barring major economic or geopolitical disruptions, it appears safe to assume that black gold is unlikely to stray far from that range for the next couple of years.

A reduction of the U.S.'s reliance on foreign oil imports requires the development of shale rock formations around the country, areas where traditional drilling methods don't work as well. The horizontal drilling and the hydraulic fracturing technology are the latest major developments in the hydrocarbon market that boosted the shale oil and gas production in North America and brought a revolution in the domestic oil and gas industry.

In addition, it does not matter whether a well is a gusher or a dry hole. The driller will be paid for his services either way.

For these reasons, among others, there will always be a baseline of drilling activity going forward, that will extend from North America to new exploration areas such as Africa, Southeast Asia, the Mediterranean, and South America. This will benefit the energy services sector that will remain a very attractive sector during this year and beyond.

This is why I decided to write few articles about the oilfield services companies, which at will be a very useful tool for all the value investors who try to identify the undervalued and the overvalued players along with some potential acquisition targets. This series captures all the onshore players with market cap up to ~$3 billion.

The distinction

In the first and second Part of this series, I pointed out that there is a lot of opportunity and lack of availability of rigs in some key international markets, while the demand in North America is flat or trending downwards. In North America, there is a fierce competition in the oilfield sector during the last couple of years that hurts the prices and reduces the margins for the majority of the companies. Add on this, some recurring problems that the companies encounter in North America (i.e. spring break up in Canada due to the severe weather in winter), and the domestic outlook for the sector is quite disheartening. My articles are here and here. All those who want to get a better idea about the ongoing situation in the oilfield sector will find both articles very useful.

Meanwhile, demand exceeds the supply in some key international markets and the international expansion is the only way for the domestic oilfield companies to buck the weakness in North America. After all, the international oilfield companies are primary acquisition targets, attracting a lot of interest from several suitors lately.

The M&A Activity

The vibrant M&A activity is focused primarily on the Canadian companies of the sector and the U.S.-based suitors pay significant premium (PBV=2 or higher) to acquire them. The most significant deals during the last couple of years are below:

1)A few weeks ago, General Electric (NYSE:GE) acquired Lufkin Industries (NASDAQ:LUFK), paying 13x Lufkin's annual EBITDA.

2) A few months ago, Western Energy Services (OTC:WEEEF) also paid a good premium (PBV=2) and acquired the Canadian IROC Energy Services.

3) In early 2012, U.S. Engineering company URS Corporation (NYSE:URS) paid a significant premium (PBV=3) to acquire the Canadian Flint Energy Services.

4) In late 2012, the U.S.-based FMC Technologies (NYSE:FTI) paid a good premium (PBV=2) to acquire Canadian Pure Energy Services. With a major portion of its total revenue coming from outside the U.S., FMC Technologies' international operations are expected to be a key growth driver, going forward. According to the company, this will also play an offsetting role to the soft domestic drilling scene. FMC has identified Latin America, Asia Pacific and the Middle East as the key markets in this regard.

5) In 2012, the U.S.-based National Oilwell Varco (NYSE:NOV) also paid a good premium (PBV=1.8) and acquired the Canadian CE Franklin.

6) Back in 2008, U.S.-based giant Schlumberger (NYSE:SLB) acquired the Canadian Saxon Energy Services to position itself in the dynamic international arena. Saxon Energy Services was characterized as "the jewel of Canadian drillers" by BMO Capital Markets and was founded by Walter Dawson. Walter Dawson has also founded both Enserco Energy Services and the Calgary-based Computalog, which have been acquired by Nabors Industries (NYSE:NBR) and Precision Drilling (NYSE:PDS) respectively.

Digging Into The Fundamentals

The key metrics and the outlook are of high importance when I am doing my due diligence. According to the latest Q1 2013 reports, the key ratios for this third group of companies from the oilfield services sector are shown below:

Company

PBV

Operating

Income

Margin (%)

EBITDA

Margin (%)

LT Debt

-----

Equity

LT Debt

-------

EBITDA*

EV

--------

EBITDA*

Dividend

FTK

5.09

16%

20%

0.17

0.44

13.82

-

FET

2.23

13%

17%

0.33

1.51

11.58

-

TTI

1.48

3%

13%

0.61

3.19

10.71

-

USAC

1.23

17%

54%

0.64

4.20

12.28

-

GSJK

1.68

17%

28%

0.08

0.40

8.75

8.7%

EV: Enterprise Value

LT: Long Term

EBITDA* : Estimated EBITDA (annualized).

Flotek Industries (NYSE:FTK) operates in three areas. Its chemicals and logistics division provides specialty chemicals used in the stimulation, cementing, and blending of oil and gas wells. The drilling products division designs and manufactures downhole tools for the energy, mining, and water industries. Its artificial lift unit supplies pumping system components, including pumps, separators and valves. Flotek also announced recently the acquisition of Florida Chemical Company, the world's largest processor of citrus oils.

According to the company's CEO, North America is a challenging operating environment for the companies of the sector. Thanks to the international markets, the company's revenue was relatively flat in Q1 2013, in comparison to Q4 2012, even as total North American drilling activity was weak and decreased by over 11% during the past 12 months.

The international markets like Mexico, the Netherlands and Turkey made significant contributions to overall chemical sales. In addition, Flotek continues its expansion strategy to new emerging markets like Guatemala, the United Arab Emirates and Oman. In Oman, Flotek recently signed a Letter of Intent with Gulf Energy, a leading Omani oilfield technology company, to jointly develop oilfield chemistry and production facilities in the Sultanate of Oman to serve the rapidly growing hydrocarbon markets in the Middle East and North Africa. In Q1 2013, Flotek's Teledrift division also posted strong results thanks primarily to the expansion to Saudi Arabia through Saudi Aramco, to Argentina and Kazakhstan.

Thanks to four acquisitions completed in Q4 2012, Forum Energy Technologies' (NYSE:FET) top and bottom line grew in Q1 2013 in comparison to Q4 2012. The Drilling & Subsea divisions benefited much from this expansion strategy but the Drilling Technologies division continued to face demand softness due to the depressed North America land drilling market.

This is why, Forum decided few days ago to strengthen the international presence of its Drilling Technologies division too by acquiring Blohm and Voss Oil Tools. Blohm and Voss manufactures a comprehensive range of pipe handling equipment used on offshore and onshore drilling rigs. Blohm + Voss Oil Tools has a significant presence in international markets complementing Forum's presence in the weak North America market.

Both Flotek and Forum trade at a very good premium primarily due to the lack of significant long-term debt.

TETRA Technologies (NYSE:TTI) provides a variety of onshore services focused on completion fluids, water management, after-frac flow back and production well testing along with selected offshore services like well plugging and abandonment, decommissioning, and diving. According to the company's CEO, TETRA had reduced earnings in Q1 2013 (excluding the results of the Maritech segment) in comparison to the previous quarters in 2012, primarily due to lower-than-anticipated onshore U.S. and Canadian activity. This dismal U.S. and Canadian activity also resulted in a very low operating margin for the company.

The weak activity in the onshore markets in the U.S. and Canada was not offset by the small exposure to Mexico. In Mexico, TETRA has seen a significant reduction in activity lately due to a reevaluation of budgeting by its major customer. However, TETRA is optimistic and remains confident that Mexico will be a major contributor to the company's growth over the intermediate- to long-term.

USA Compression Partners LP (NYSE:USAC) is a new entrant in the sector and closed its initial public offering in January 2013. This is another provider of compression services to producers, processors, gatherers and transporters of natural gas. USA Compression focuses on deploying large HP infrastructure applications primarily in high volume gathering systems, processing facilities and transportation applications.

The company's eye-catching EBITDA margin is offset by the high debt and the zero international exposure. To me, the company is richly valued at the current levels.

Compressco Partners L.P. (NASDAQ:GSJK) provides compression-based production enhancement services for natural gas and oil exploration and production companies. Its production enhancement services are used in both conventional wellhead compression applications and unconventional compression applications.

TETRA and Compressco have a synergistic relationship. TETRA is the majority owner and general partner in Compressco Partners LP. When TETRA opens the door with a customer through production testing or other services, Compressco follows up with well enhancement services.

In Q1 2013, Compressco continued its expansion to the domestic conventional and unconventional applications, particularly liquids-rich shale plays, and it also invested significant capital on its international operations that extend from Mexico to Eastern Europe and the Asian-Pacific region.

Compressco might be an interesting play for income seekers due to its dividend. Nevertheless, the company is fairly valued currently and I do not expect significant capital gains from this stock.

After all, I am not bullish for any of the aforementioned companies, because I do not consider any of them to be undervalued at the current levels. To me, they are either richly or fairly valued.

Conclusion

In my future articles I plan to cover the big and the intermediate oilfield companies along with the offshore players of this industry. I believe it will be a very interesting read primarily for value investors who want to buy low and sell high. Stay tuned!

Source: Drilling Into The Oilfield Services Companies To Find Long And Short Candidates (Part III)