Pason: A Hidden Gem In North American Drilling

| About: Pason Systems (PSYTF)

Pason Systems headquartered in Calgary, Canada supplies control and monitoring equipment to the oil and gas drilling industry. Sales are largely generated in North America with less than 10% of the revenues coming from other geographies such as Australia and South America.

The company has been run by Jim Hill following its sale by Badger Drilling in 1987 when it had revenues under a million dollars (all dollar figures in this article are Canadian). Pason revenues took off in the 90s with the introduction of the Electronic Drilling Recorder (EDR) which allowed detailed live monitoring of the drilling process. The period 2000-7 saw explosive growth for the company as it increased market share and introduced new products. Revenues and EPS increased by more than 6x over that time. Shares in the company also rose dramatically in price from under $2/share on a split adjusted basis to a 2007 peak around 17. The 2008-9 economic downturn that was marked by a sharp decrease in drilling activity dropped the share price by about half and Pason recorded a small loss in 2009. But since then business has rebounded very nicely and 2011 revenues are projected to be at record levels. ($330 MM) With still one quarter to report, 2011 EPS are projected to come in around 1.02 which would also be a record. The share price however is currently around 13 is well below the 2007-8 peak values.

While the EDR remains the most important product, Pason sells a full line of products such as Pit Volume Totalizer, Automatic Driller and other communications equipment that allow drillers to closely monitor the entire drilling process. In 2009 Pason acquired Houston based Petron Industries, a move that extended the company into offshore drilling applications. Last year Pason acquired Austin, TX based 3PS, Inc. for $23.9 MM, a firm that had new torque and overhead crane sensing technology. Pason is likely to turn the 3PS technology into a rental product according to analyst reports. The 3PS technology and new gas analyzer technology are seen as growth drivers over the next 12-24 months. The company reports good market acceptance so far for both. Pason is also clearly benefitting from the new more complex multi-directional drilling in North American shale regions. More complex wells require a larger number of drilling days.

Pason has a dominant share of the Canadian market with equipment installed on 93% of drilling rigs and a leading position in the US where 62% of rigs use the Pason EDR system. Pason sees further penetration of the US market as another growth opportunity. The company views National Oilwell Varco as its leading competitor.

With its strong growth prospects Pason appears to be undervalued at the current price about 13x 2011 EPS, less than 9.3x forward earnings and less than 8x cash flow. One analyst firm (First Energy Capital) recently increased its target price to $19 (November report) with an Outperform rating. The full report is available on the Pason website.

The company has a strong balance sheet with $90 MM in cash and no long term debt. The company recently increased its dividend by 11% to 0.40/share. (corresponds to about 3%)

Pason has historically had a strong history of insider stock ownership. I like this since it acts to align shareholder and management interests. Currently about 22% of the float in owned by management and directors. Late in 2011 it was announced that Jim Hill would monetize a small portion of his shares, but he will retain a very significant ownership position. Hill has also very recently relinquished the CEO title to Marcel Kessler but Hill is staying very involved as an active hands-on Chairman.

Pason remains a relatively unknown name to US investors. Once exception is small cap expert Royce Mutual Funds which has invested in the shares for more than 5 years.

Currently Pason is listed on the Toronto Stock Exchange under the symbol PSI. US investors can also invest through OTCPK:PSYTF on the pink sheets, although that is thinly traded. At some point a listing on the NASDAQ or other US based exchange would seem to be a way for the company to gain further recognition among the US investor community.

I have recently purchased shares in Pason for both my individual accounts and for accounts managed for Freedom Mountain Investment clients.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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