Superior Well Services:
- Ticker: SWSI
- Recent price: $15.85
- $528M market capitalization
- Positiontype: Trading Long (at least into 2Q2010 earnings, but watch balance sheet liquidity)
Catalysts for Stock Appreciation/Multiple Expansion:
1.) Pressure pumping pricing and utilization rising: SWSI has been through a significant operational downturn that correlated with the rapid decline in the North American rig count during the latest economic recession. However, SWSI has emerged and may be entering a multi-quarter period of renewed pricing and margin improvement driven by the rapid tightening of the pressure pumping market in North America's major shale plays.
As evidence, in SWSI's 1Q2010 conference call, average sales discounts across SWSI's service lines decreased by 1.2% relative to the previous quarter. SWSI's management also indicated that they continue to see pricing improvements and lower discounts driven by increased utilization, and that these improvements accelerated toward the end of the first quarter. Since SWSI reported 1Q2010, Schlumberger and others have implemented pressure pumping price increases of 15% or more. SWSI should be able to pass along similar increases.
2.) Play on rising natural gas prices and onshore drilling activity (the "anti-offshore" services play):
Since the 1Q2010 report, spot natural gas prices have risen 20+%, so operational momentum should at least hold, if not improve. Rising natural gas prices are important for operator confidence and cash flow, allowing them to increase drilling and completion activity in existing and new wells. Also, as the entire natural gas futures curve has shifted up and remains in contango, operators can now lock in higher future cash flows through commodity hedging strategies.
Finally, all of SWSI's services business relates to onshore North American activity. SWSI may be relatively more attractive to energy services investors given the potential for a political tilt toward natural gas and away from offshore drilling and oil.
Brief Company Background:
SWSI is the 5th largest pressure pumper in the U.S, with roughly 7% market share (as measured by horsepower) and 19 service centers covering 38 states. Pressure pumping involves the injection of gel-like fluids, foams, and/or specially formulated acids down into a well at a sufficient pressure level to both fracture and dissolve barriers in the rock formation. This effort often improves hydrocarbon production from the well. There is also some cementing work that is typically involved in this process. In total, these services comprise over 85% of the revenue base for SWSI. The rest is made up of other related onshore completion and production as well as down-hole services revenues.
Competition: HAL, SLB and BHI/BJS control 18.0%, 15.0% and 13.0%, respectively, of the pressure pumping market. Competitive pressures are generally intense with many smaller private companies participating as well. For a company of its size, SWSI holds significant geographic presences across all of the major shale plays in North America.
1.) SWSI turned EBITDA positive in 1Q2010. This uptick in profitability is impressive given the relatively slow improvement off the bottom in both natural gas prices and the natural gas rig count to-date. It could point to a higher level of contribution margin than in prior upturns, should the pressure pumping business continue to exhibit pricing and utilization improvements in coming months.
2.) SWSI experienced a sequential quarterly increase of 23% in activity despite the fact that SWSI's largest segment (by horsepower capacity, Appalachia) was down 14% sequentially primarily due to seasonal weather conditions. Such conditions should abate in coming quarters, and return this segment to a more normalized revenue contributor. Despite SWSI's lower overall pressure pumping market share, SWSI possesses a leading competitive position in the Marcellus Shale with 127,000 hp operating.
3.) SWSI's geographic revenue exposures as of 1Q2010:
- Appalachia (Revenue: $30.0 million, 24.3% of total). This segment was down 14% sequentially.
- Southwest (Revenue: $30.5 million, 24.7% of total)
- Southeast (Revenue: $22.4 million, 18.2% of total). Includes the Haynesville Shale; SWSI is
- entering the Eagleford Shale starting in the second quarter.
- Mid-Continent (Revenue: $23.8 million, 19.3% of total) – Includes the Fayetteville and Woodford Shales as well as the Granite Wash region.
- Rocky Mountains (Revenue: $16.7 million, 13.6% of total). Smallest segment, but growing rapidly (was up 80% sequentially in 1Q2010). Includes the Bakken Shale, where oil drilling has been expanding exponentially.
1.) SWSI's balance sheet is definitely subbar (a big part of the short story (short interest in the stock is about 17%). SWSI's liquidity is tight: The cash on balance sheet remains fairly minimal, and capex is projected at $20M range for 2010. However, the company is leaner than before the downturn began, and should generate free cash flow in coming quarters. SWSI has enough capacity on their credit facility to fund any near-term funding gaps. The stock could witness a short-squeeze if liquidity improves more than expected due to a better operating environment (and thus greater levels of operating cash flow) and/or rising natural gas prices, both of which seem increasingly likely in the near-term.
2.) Adjusted for a recent $34.6 million tax refund, SWSI had an adjusted debt-to-book capitalization of approximately 29%, so there is room for the company to expand its leverage if necessary.
Valuation and Sentiment: Using a $19 target price
With an enterprise value (EV) of about $770M and 2010 consensus EBITDA estimates around %73M, SWSI's static EV/EBITDA ratio currently hovers around 10x, which is expensive. On a go-forward basis, quarterly EBITDA could approach $27M exiting 2010, especially if pressure pumping market momentum continues. At 8x this EBITDA run-rate, SWSI would be valued at $19, or about 20% upside from the current price. In addition, the current stock price is implying much lower levels of return on capital invested relative to to 2004 through 2008 period. Thus there is room for the stock to rise.
Outside of standard valuation techniques, further consolidation among pressure pumpers is likely. SWSI is a prime target now that B.J. Services (BJS) was recently acquired by Baker Hughes. In addition, the lack of a strong balance sheet makes SWSI's management more likely to consider strategic alternatives to enhance shareholder value (i.e., selling the company).
Disclosure: Author holds a long position in SWSI