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Summary

  • The tactical initiatives should improve the business by increasing revenue, cash flow, and earnings.
  • TETRA's overall valuation is fair as compared to the industry.
  • The stock is likely to rise as TETRA's initiatives drive an improvement in earnings consistency.

Tactical Initiatives

TETRA Technologies (NYSE:TTI) has implemented multiple tactical initiatives over the past 18 months to improve the business, which are designed to lead to improved cash flow and consistent earnings. These initiatives include expanding certain businesses and lowering costs. The company missed its earnings estimates for 3 out of the past 5 quarters, so the initiatives are a step in the right direction for TETRA to achieve improved future performance. TETRA recently missed on the top and bottom lines for Q1 2014. Revenue for Q1 of $211.5 million was $6 million below estimates and EPS of -$0.04 missed estimates by $0.09. The stock fell 8% as a result of the disappointing earnings report. Hopefully for shareholders, TETRA's initiatives will lead to an overall improved business, which will lead to more earnings beats than misses in the future.

One initiative was the reorganization of the Offshore Services Division, which provides down hole & subsea services, construction services, and air diving services. TETRA was able to reduce costs by $19 million. This enabled the division to generate strong free cash flow with little capital and a strong backlog. With improved cash flow, TETRA is better able to fund its growth going forward.

The Offshore Services reorganization has proved successful as measured by the cost savings. I think that TETRA's efforts to streamline its Offshore Services can complement the division's backlog. With a solid backlog and cost savings, this division is better positioned for future growth in the form of improved cash flow and increases in earnings.

Another initiative was getting the Maritech wells abandoned and decommissioned. Over the past 18 months, 6 out of 10 operated properties were addressed. Getting the six operated properties completed have left TETRA Tech with two properties with challenging wells with formation pressure and two that require good weather to execute. The company plans on resuming and completing the work on the remaining wells this quarter and completing the abandonment and decommissioning work by the end of the third quarter. Getting Maritech completed will allow Tetra to focus on its other businesses. The abandonment of the final wells looks likely to be completed in the third quarter, as the spring weather is conducive to finishing the work.

There is an initiative to expand the U.S. Compressco business by adding vapor recovery units and mid-sized compressors to offset the decline in activity in Mexico. Despite the challenging market in Mexico, TETRA was able to increase distributions in six out of the past seven quarters. Tetra can continue the growth of Compressco via organic growth and through acquisitions.

The Compressco initiative is likely to succeed because it involves adding useful equipment for customers that address marginal and low pressure wells. Marginal wells currently represent over 64% of all domestic natural gas wells, but account for less than 10% of total domestic production. Vapor recovery units will allow customers to recover fuel vapors to prevent them from being released in the atmosphere, which is important in this increasingly environmentally sensitive era. These units can be easily added to Compressco's U.S. business to increase revenue and offset the decline in Mexico.

TETRA plans to grow its water handling business by introducing a lay flat hose with the rapid deployment units. The company now has units deployed in the U.S. and Canada. TETRA plans on continuing its growth in North America while also looking to expand internationally. This business is capitalizing on the growth in fracking activity.

The implementation of lay flat hoses is likely to be successful because these are less costly than using metal pipes to transfer water. Lay flat hoses are also easier to handle, as the technology is similar to fire hoses.

TETRA reduced its General and Administrative (G&A) cost structure. Thus far, the company achieved $13 million in savings with a goal of $15 million. TETRA achieved this by consolidating accounting functions and eliminating staff and levels of management. The company is on target to hit its goal of $15 million in the near future. This adds to the company's total cost savings, which improves the bottom line.

TETRA also implemented an initiative to strengthen its sales force in North America and to reduce its dependence on a number of anchor accounts. The company still has a lot of work to do with this initiative as compared to the others. The success of this initiative should produce increased accounts, thus creating an increased stream of revenue from a broader network of customers.

This will probably be the most challenging initiative for TETRA as it involves taking on new accounts rather than introducing new products to existing accounts. Although challenging, it is not out of reach for the company. The initiative just needs to be well planned and executed for tangible results.

All of these initiatives should help TETRA increase revenue, cash flow and achieve increased earnings. The initiatives should also lead to more consistent earnings. The stock price has not returned to its highs from before the 2008 financial crisis. These initiatives should put TETRA on the path to improving its stock price as the fundamentals improve over the long term. From 2011 through 2013, TETRA has produced a negative free cash flow as it spent more on capital expenditures than it had in operating cash flow. The company's initiatives should help bring free cash flow closer to the positive side and keep it there for the future.

TETRA's Valuation vs. Competitors

Tetra faces large competitors such as Anadarko Petroleum (NYSE:APC), Halliburton (NYSE:HAL), and Weatherford International (NYSE:WFT). The company also competes with smaller companies such as AECOM Technology (NYSE:ACM) and Foster Wheeler (NASDAQ:FWLT).

Here is a side-by-side comparison of the key valuation metrics with data derived from Yahoo Finance and Morningstar:

Tetra Tech

Anadarko

Halliburton

Weatherford

AECOM

Foster Wheeler

EV/EBITDA

14

6.31

9.49

12.49

8.24

12.13

3 yr. Price to Cash Flow

12.4

6.2

11

19.4

8.5

17.9

Price to Sales

0.98

3.26

1.79

1.07

0.39

1.01

5 yr. Annual Expected Earnings Growth

15%

14.4%

23%

43%

9.5%

17%

Expected 2014 Revenue Growth

12%

16%

9.2%

2.8%

-4%

15%

Expected 2015 Revenue Growth

7.7%

1%

3.1%

8.1%

4.6%

17%

When analyzing this data, TETRA's price to sales ratio is attractively undervalued in relation to the industry. I think that the price to cash flow and EV/EBITDA also holds weight in the oil and gas services industry. Tetra needs strong cash flow to pay for its growth. Tetra's 3-year price to cash flow turns out to be the average of the companies included in the chart. Therefore, Tetra is fairly valued in terms of cash flow. Tetra's five-year price to cash flow is 23.2, so the company is making progress with this metric. The improvements in cash flow are evident as Tetra achieved $20 million in free cash flow in Q1 excluding Maritech. The free cash flow was $7 million with Maritech included. This shows that the tactical initiatives are working as free cash flow turned positive. I would expect those gains in free cash flow to continue as Tetra's initiatives continue to materialize.

I like EV/EBITDA as a valuation metric since it takes the tax implications out of the equation. At first glance, Tetra looks overvalued as compared to its competitors in terms of EBITDA. The company's initiatives should help improve EBITDA and cash flow. It will probably take at least a few quarters for Tetra to improve its cash flow and earnings. I included the expected revenue and earnings growth in the chart because I wanted to show if Tetra's valuation was worth the premium in EV/EBITDA. Tetra's expected earnings are below the average. This is skewed slightly because of Weatherford's high expected growth. Regardless, Tetra doesn't have an advantage in expected earnings to warrant such a high EV/EBITDA. However, on the revenue side, Tetra has above average revenue projections. I think that Tetra's higher EV/EBITDA is justified by its above average revenue projections. I also see the projected revenue and the attractiveness of Tetra's price to sales ratio as a balance to the high EV/EBITDA to justify giving Tetra an overall fair valuation. However, I would like to see the EV/EBITDA decrease in the future. Tetra's initiatives to improve the business should lead to a lower EV/EBITDA in the future.

(click to enlarge)

What is the likely direction for the stock?

The oil and gas services industry is highly competitive. TETRA's tactical initiatives are a step in the right direction to grow the business and to remain competitive. The company does face risks related to government spending and competition. In 2013, TETRA derived 46.8% of revenue from contracts with U.S. federal, state, and local government agencies. This is broken down to 12.1% from DoD agencies, 9.7% from USAID, and 10% from other U.S. federal agencies. Therefore, Tetra is significantly levered to the amount of government spending and budgetary constraints. If government spending is cut for TETRA's offerings, the stock could be subject to declines.

The competition in the oil and gas services industry is intense. TETRA not only faces competition from publicly traded companies, but also from privately run businesses. The company needs to continue its tactical initiatives so that it can grow its market share in the industry. The current initiatives that are in place should ensure that TETRA expands its piece of the industry pie. If the initiatives continue to be successful as measured by increases in revenue, cash flow, and earnings, then I think the stock will respond favorably.

TETRA's stock has traded with sharp increases and decreases within just a few months. Swings of 30% or more in both directions have been common for the past few years. I think that the company needs to show consistent improvements in cash flow and earnings for a few quarters for the stock to break out to new highs. The tactical initiatives in place are likely to lead to cash flow and earnings increases, which should drive the stock higher over the long term.

Source: Tactical Initiatives To Improve Tetra Technologies