Seeking Alpha
Value, research analyst, energy, dividend growth investing
Profile| Send Message|
( followers)  

For investors looking for a growing small-cap company that has attractive valuations and is focused on creating shareholder value, Trinidad Drilling LTD (OTCPK:TDGCF) is a growth oriented, dividend paying oil and gas service company based out of Calgary, Alberta worth consideration.

Trinidad Drilling LTD provides modern, reliable, expertly designed oil and gas drilling equipment operated by well-trained personnel. The company's drilling fleet is one of the most adaptable, technologically advanced and competitive in the industry.

Over the past couple of years, the Oil and Gas equipment service industry has evolved rapidly. With the introduction of new fracking techniques, horizontal drilling, increased safety regulations and domestic demands showing no signs of slowing down, energy service companies with the financial leverage to make quick adaptations and possess technologically advanced deep drilling rigs that are cost efficient with improved safety features are the companies that will do well in this energy cycle.

In the section below, I will analyze aspects of Trinidad Drilling's past performance. From this evaluation, we will be able to see Trinidad's profitability, debt and capital, and operating efficiency. Based on this information, we will look for strengths and weaknesses in the company's fundamentals. This should give us an understanding of how the company has fared over the past few years and will give us an idea of what to expect in the future

Profitability

Profitability is a class of financial metrics used to assess a business's ability to generate earnings compared with expenses and other relevant costs incurred during a specific period of time. In this section, we will look at four tests of profitability. They are: net income, operating cash flow, return on assets and quality of earnings. From these four metrics, we will establish if the company is making money and gauge the quality of the reported profits.

  • Net income 2010 = $(82) million
  • Net income 2011 = $76 million
  • Net income 2012 = $55 million
  • Net income 2013 TTM = $41 million

TDGCF Net Income TTM Chart

TDGCF Net Income TTM data by YCharts

Over the past three years Trinidad's net profits have increased from $(82) million in 2010, to $41 million in 2013 TTM. This represents a 62.02% increase.

  • Operating income 2010 = $3.0 million
  • Operating income 2011 = $134.8 million
  • Operating income 2012 = $91.8 million
  • Operating income 2013 TTM = $69.9 million

Operating income is the cash generated from the operations of a company, generally defined as revenue less all operating expenses, but calculated through a series of adjustments to net income.

Over the past three years Trinidad's operating income has increased from $3.0 million to $69.9 million in 2013 TTM. This represents an increase of 64.03%.

ROA - Return On Assets = Net Income/Total Assets

ROA is an indicator of how profitable a company is relative to its total assets. ROA gives an idea as to how efficient management is at using its assets to generate earnings. Calculated by dividing a company's net income by its total assets, ROA is displayed as a percentage. Sometimes this is referred to as "return on investment."

  • Net income growth

    • Net income 2010 = $(82) million
    • Net income 2011 = $76 million
    • Net income 2012 = $55 million
    • Net income 2013 TTM = $41 million
  • Total asset growth

    • Total assets 2010 = $1.539 billion.
    • Total assets 2011 = $1.608 billion.
    • Total assets 2012 = $1.541 billion.
    • Total assets 2013 TTM = $1.551 billion.
  • ROA - Return on assets

    • Return on assets 2010 = -5.33%.
    • Return on assets 2011 = 4.73%
    • Return on assets 2012 = 3.57%.
    • Return on assets 2013 TTM = 2.64%

Over the past three years Trinidad's ROA has increased from -5.33% in 2010 to 2.64% in 2013 TTM. This indicates that the company is generating significantly more income on its assets than it did in 2010.

ROE - Return on Equity = Net Income / Shareholders' Equity

As shareholders' equity is measured as a firm's total assets minus its total liabilities, ROE reveals the amount of net income returned as a percentage of shareholders' equity. The return on equity measures a company's profitability by revealing how much profit it generates with the amount shareholders have invested.

  • 2010 - $(82) million / $778 million = -10.54%
  • 2011 - $76 million / $841 million = 9.04%
  • 2012 - $55 million / $864 million = 6.37%
  • 2013 TTM - $41 million / $902 million = 4.55%

Much like the ROA, the ROE is showing increasing profitability. Since 2010 the ROE has increased from -10.54% to 4.55%. As the ROE has increased over the past four years, this reveals that there has been an increase in how much profit has been generated compared to the amount that shareholders have invested, thus indicating an increase in shareholder value.

Quality Of Earnings

Quality of earnings is the amount of earnings attributable to higher sales or lower costs rather than artificial profits created by accounting anomalies such as inflation of inventory. To ensure there are no artificial profits being processed, the operating cash flow must exceed the net income.

2010

  • Operating income 2010 = $3.0 million
  • Net income 2010 = $(82) million

2011

  • Operating income 2011 = $134.8 million
  • Net income 2011 = $76 million

2012

  • Operating income 2012 = $91.8 million
  • Net income 2012 = $55 million

2013 TTM

  • Operating income 2013 TTM = $69.9 million
  • Net income 2013 TTM = $41 million

Over the past three and a half years, the operating income has been higher than the net income in all years. This indicates that Trinidad Drilling is not artificially creating profits by accounting anomalies such as inflation of inventory.

Debt And Capital

The Debt and Capital section establishes if the company is sinking into debt or digging its way out. It will also determine if the company is growing organically or raising cash by selling off stock.

Total Liabilities To Total Assets, Or TL/A ratio

TL/A ratio is a metric used to measure a company's financial risk by determining how much of the company's assets have been financed by debt.

  • Total assets

    • Total assets 2010 = $1.539 billion.
    • Total assets 2011 = $1.608 billion.
    • Total assets 2012 = $1.541 billion.
    • Total assets 2013 TTM = $1.551 billion
    • Equals an increase of $12 million
  • Total liabilities

    • Total liabilities 2010 = $760 million
    • Total liabilities 2011 = $767 million
    • Total liabilities 2012 = $677 million
    • Total liabilities 2013 TTM = $649 million
    • Equals an decrease of $111 million

Over the past three and a half years, Trinidad's total assets have increased by $12 million, while the total liabilities have decreased by $111 million. This indicates that the company's assets have increased more than the liabilities thus adding shareholder value.

Working Capital

Working Capital is a general and quick measure of liquidity of a firm. It represents the margin of safety or cushion available to the creditors. It is an index of the firm's financial stability. It is also an index of technical solvency and an index of the strength of working capital.

Current Ratio = Current assets / Current liabilities

  • Current assets

    • Current assets 2010 = $198 million
    • Current assets 2011 = $240 million
    • Current assets 2012 = $201 million
    • Current assets 2013 TTM = $201 million
  • Current liabilities

    • Current liabilities 2010 = $71 billion
    • Current liabilities 2011 = $100 billion
    • Current liabilities 2012 = $92 billion
    • Current liabilities 2013 TTM = $95 billion
  • Current ratio 2010 = 2.79
  • Current ratio 2011 = 2.40
  • Current ratio 2012 = 2.18
  • Current ratio 2013 TTM = 2.12

Over the past three and a half years, Trinidad's current ratio has been declining. As the most recent current ratio is well above 1, this indicates that Trinidad Drilling would be able to pay off its obligations if they came due at this point.

Common Shares Outstanding

  • 2010 shares outstanding = 121 million.
  • 2011 shares outstanding = 121 million.
  • 2012 shares outstanding = 121 million
  • 2013 TTM shares outstanding = 121 million

Over the past three and a half years, the number of company shares have remained at 121 million.

Operating Efficiency

Operating Efficiency is a market condition that exists when participants can execute transactions and receive services at a price that equates fairly to the actual costs required to provide them. An operationally efficient market allows investors to make transactions that move the market further toward the overall goal of prudent capital allocation without being chiseled down by excessive frictional costs, which would reduce the risk/reward profile of the transaction.

Gross Margin: Gross Income/Sales

The Gross Profit Margin is a measurement of a company's manufacturing and distribution efficiency during the production process. The gross profit tells an investor the percentage of revenue/sales left after subtracting the cost of goods sold. A company that boasts a higher gross profit margin than its competitors and industry is more efficient. Investors tend to pay more for businesses that have higher efficiency ratings than their competitors, as these businesses should be able to make a decent profit as long as overhead costs are controlled (overhead refers to rent, utilities, etc.).

  • Gross margin 2010 = $252 million / $647 million = 38.95%.
  • Gross margin 2011 = $308 million / $797 million = 38.64%.
  • Gross margin 2012 = $329 million / $859 million = 38.30%.
  • Gross margin 2013 TTM = $312 million / $837 million = 37.28%.

Over the past four years, Trinidad's gross margin has remained relatively steady. The ratio has decreased from 38.95% in 2010 to 37.28% in 2013 TTM.

Asset Turnover

The formula for the asset turnover ratio evaluates how well a company is utilizing its assets to produce revenue. The numerator of the asset turnover ratio formula shows revenue found on a company's income statement and the denominator shows total assets, which are found on a company's balance sheet. Total assets should be averaged over the period of time that is being evaluated.

  • Revenue growth

    • Revenue 2010 = $647 billion
    • Revenue 2011 = $797 billion
    • Revenue 2012 = $859 billion
    • Revenue 2013 TTM = $837 billion
    • Equals an increase of 29.40%.
  • Total Asset growth

    • Total assets 2010 = $1.539 billion.
    • Total assets 2011 = $1.608 billion.
    • Total assets 2012 = $1.541 billion.
    • Total assets 2013 TTM = $1.551 billion
    • Equals an increase of 0.80%.

Over the past three and a half years the revenue growth has increased by 29.40% while the assets have increased by 0.80%. This is an indication that the company from a percentage point of view has been more efficient at generating revenue.

Based on the information above we can see that Trinidad Drilling has produced very strong results from a fundamental point of view. Revenues over the past three and a half years, have increased by 29.40%, the ROA and ROE have both been indicating an increase in profitability, while the assets have remained relatively the same, the company has reduced its liabilities. Based on the results above we can see that the company has produced very strong results.

Catalysts Moving Forward

Over the past few years Trinidad's management team has refocused the company to concentrate on the deep drilling market, increase leverage by reducing debt and explore international markets. By refocusing the company, management is looking to capitalize on the growing deep-drilling market thus increasing efficiency and profitability and creating shareholder value.

To capitalize on the growing demand for oil and gas services, the Trinidad Drilling management team has streamlined their assets to focus on the deep-drilling market. They have done this by selling off their older and shallow drilling rigs and refocused their fleet on "high performance" deep drilling rigs. Currently, 87% of Trinidad Drilling's rigs have the ability to drill wells deeper than 6,000ft or more while 77% of the company's total rigs are considered "high performance."

Because of Trinidad's focus on high performance rigs, the company recently signed a contract to build a new rig designed to drill natural gas in the Laird Basin. The project headed by both Apache Energy (NYSE:APA) and Chevron (NYSE:CVX), who have a 50/50 split in the Basin, anticipate that this rig will be one of Canada's largest and most technically advanced land rigs. Construction of the rig is expected to be completed in Q3 of 2014 and will operate under a five-year, take-or-pay contract.

To increase leverage and give management the opportunity to be flexible and capitalize on opportunities as they appear, they have set a goal to have a total debt / adjusted EBITDA ratio of 1.50. As you can see by the chart below management has been successful in reducing this ratio. Based on future projections, management anticipates to reach this goal in 2014.

In the company's pursuit of exploring international markets, on September 3rd, 2013, Management signed a joint venture with Halliburton Inc. (NYSE:HAL). This joint venture is expected to increase revenue from markets outside the U.S. and Canada. Through the joint venture Trinidad Drilling will have access to more than 20 different countries. As Trinidad will be the majority shareholder in the venture with 60% ownership, while Halliburton will own the other 40%, each party will contribute to future capital projects in their respective proportions.

As Trinidad's management team has set the company up to increase earnings through new international markets, increase cash flow and leverage through the reduction of debt and increase the customer base and demand through high performance, efficient, safety based equipment and personnel, 2014 looks to be a strong year for Trinidad Drilling.

Revenue Growth

Now with access to more than 20 different countries through Halliburton, revenue based from international markets is expected to lead the company's growth in the future. Currently, Trinidad Drilling is expected to supply four rigs to work in the Kingdom of Saudi Arabia for a period of three years along with a provision for one-year extension.

As the joint venture opens up opportunities for Trinidad Drilling, international revenue are expected to increase significantly in 2014. As the company is expecting to begin operations in Saudi Arabia and Mexico, the 2014 total revenue is expected to increase by 7.41%.

Estimated Free Cash Flow

As a result of the discipline displayed by management, by increasing revenue streams and reducing debt, the company's free cash has steadily been on the rise. As the chart below indicates, the company's free cash has increased from (20) million in 2010 to the current level of $116 million. To continue with the company's growth, in 2014 Trinidad's operating cash flows are estimated to be in the $260 million range while Capex spending is estimated to be around $148 million. Based on these figures, Trinidad's free cash should be around $112 million in 2014. This is slightly below the current free cash of $116 million but still significantly above the 2010 mark.

(click to enlarge)

Dividend

Since April 15th 2009, Trinidad Drilling has offered a dividend of $.05 per quarter or $.20 a year. As company earnings and cash have increased over the past four years, while management has been reducing its net debt, I believe a dividend increase is a distinct possibility. If we look at the payout ratio over the past three years and average it out, we get a payout ratio of .35. If Trinidad earns $.82 per share in 2014, as estimates indicate, and has a payout ratio of 0.30, which is inline with the payout ratio over the past few years, that would equate to a dividend of $.245 per year or $.06125 per quarter. A dividend of .245 would indicate a 22.5% increase over the current dividend of $.20.

Valuations

In the section below, I will use a couple of different methods to find a valuation for the stock price of Trinidad Drilling. In this section, I will use the Discounted Cash Flow valuation find the current value of the stock and the estimated EV/EBITDA ratio to find where the company trades in relation to its sector. Using EV/EBITDA forward estimates, I will be able to calculate a forward price target for the company.

DCF Valuation

I believe using the Discounted Cash Flow valuation model for Trinidad Drilling to be fair because DCF analysis can help one see where the company's value is coming from and one can generate an opinion based on that.

(click to enlarge)

Even though there are variations in calculating this formula, this model is based off of a terminal value of $2.612 billion and a WACC of 10.53%. The terminal value of $2.612 billion is based off of the company trading at 14X EBITDA (unadjusted). In my opinion using a terminal value of $2.612 billion based off an estimate of 14X EBITDA is fair as currently the stock is trading at 17.8X EBITDA. Using the DCF valuation method, I have concluded Trinidad Drilling stock has a value of $14.11 per share.

EV/EBITDA

In the next section, I will use the Adjusted EBITDA to calculate the EV/EBITDA. The adjusted EBITDA takes into account foreign exchange and share-based payment expenses. The EV/EBITDA ratio is one of the most commonly used valuation metrics, as EBITDA is commonly used as a proxy for cash flow available to the firm. Oil and gas services stocks typically have an EV/EBITDA ratio that trades in the 6.0x to 8.0x trading range.

Enterprise Value or EV = Market Capitalization + Total Debt - Cash and Cash Equivalents.

  • EV - $1.282 billion + 466 million - 27 million = $1.721 billion
  • Adjusted EBITDA = 277 million
  • EV/EBITDA = 6.21

As the oil and gas services sector often trades in the 6.0x to 8.0x trading range, an EV/EBITDA ratio of 6.21 indicates at current levels the stock is trading at the lower end of the valuation range.

EV/EBITDA to find a Target Price

Based on a 2014 estimated EBITDA of $298 million and using the current valuation of 6.21 EV/EBITDA, I will be able to come up with a target for the company.

Information presented below is needed to calculate this formula.

  1. Estimated Net debt = $314 million
  2. Estimated cash and cash equivalents = $27 million (same)
  3. Estimated future EBITDA (2014) $298 million
  4. EV/EBITDA = 6.21 (current valuation)
  5. Shares Outstanding = 121 million
  • 2014 equity value = 6.21 x $298 million = $1850
  • Equity Value - net debt + cash = Enterprise Value (EV) = $1.563 billion
  • EV / Shares outstanding = $1.563 billion / 121 million
  • Target Price of = $12.92 per share

Based on the EV/EBITDA formula to find a valuation, I have concluded a current value of $12.92 per share.

In other valuations, Trinidad's stock has a P/B of 1.35, which is slightly above the industry average of 1.33, A P/S of 1.46, which is well below the industry average of 2.17 and a P/CF of 5.4, which is also below the industry average of 6.37.

The valuation metrics listed above indicate that Trinidad Drilling is currently on the lower end of the valuation range. Trading at 6.2X EV/EBITDA reveals that there is upside potential from this point. The upside is revealed in the valuation price target of $12.92 per share. This valuation indicates 31.8% upside from this point.

Conclusion

2014 looks to be a strong year for Trinidad Drilling. The company's strategy to concentrate on the deep drilling market, along with the discipline of debt reduction and the joint venture with Halliburton all look to increase shareholder value in 2014. International revenues look to lead the way as Trinidad Drilling will begin operations in Saudi Arabia and should re-ignite operations in Mexico. With increased revenues and debt reduction increasing shareholder value, I believe a dividend increase in 2014 is a distinct possibility. All of the valuation indicators except for the Price/Book indicate that the company is currently trading at the lower end of its trading range. Currently, both the Discounted Cash Flow valuation model and the EV/EBITDA price valuation model indicate the stock is undervalued. These valuations models indicate that the stock is currently undervalued by 31% to 43%. As the Beta for the stock is above 2, this indicates the stock is quite volatile, so if the market continues its bull run and operations proceed as predicted, I believe Trinidad Drilling should reach this valuation by mid 2014. For investors looking for an aggressive small cap company that has many attractive catalysts for growth and is creating shareholder value, Trinidad Drilling LTD is a growth oriented, dividend paying oil and gas service company on the verge of delivering significant gains in 2014.

Source: Management's Strategies Should Deliver 30% Upside For Trinidad Drilling Ltd.