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The U.S. investing world is all too familiar with the rise of hydraulic fracturing technology and its breakthrough allowing the U.S. to re-emerge as a significant oil and gas producer. What people might not realize is that Canada is experiencing its own shale revolution thanks to hydraulic fracturing. There has been a major shift over the last couple of years from vertical drilling to horizontal drilling.

As in the U.S., there are smaller Canadian oil and gas service companies that provide investors with exposure to hydraulic fracturing. These companies include Calfrac Well Service (OTCPK:CFWFF), Trican Well Services (OTCPK:TOLWF), GasFrac Energy Service (OTCPK:GSFVF), and Canyon Services Group (OTC:CYSVF). Canyon Services appears to be the most undervalued of the Canadian service companies.

Margins

When comparing the Canadian pure play fracking companies, Canyon Services has superior profit margins by almost 2-to-1 across the board. Management has controlled costs as they dramatically increased revenue while continuing to expand margins, despite a debt-free balance sheet. This is excluding the second quarter falling in Canadian rainy season, which almost shuts down drilling until early June. Canyon Services not only holds its own against its U.S. peers, namely C & J Energy (NYSE:CJES), RPC Inc. (NYSE:RES), and Key Energy Services (NYSE:KEG). It has twice as impressive profit margins, excluding C & J Energy. (We are also long C & J Energy). Canyon Services is one of our favorite picks in the industry based on projected earnings and a 5% dividend.

Operating Area

Canyon Services currently operates in the Western Canadian Shale Basin as well as the Canadian side of the Bakken Shale, which is all the rage in the U.S. oil sector. These plays require multistage fracturing, which help keep rates high for Canyon and in turn allow them to maintain their healthy margins. This will likely increase as drilling picks up in the second half of 2012 with the Duvernany Shale play ramping up production.

Financial Summary

Canyon Services have come a long way in the last four years with respect to the growth rates across the board. The company's rapid growth has not resulted in a contraction of operating or net profit. The company boasts impressive 22% net income margins and 41% EBITDA as well.

Canyon Services is starting the year with 175,000 HP and expected to start the third quarter with 225,000 HP. Canyon is currently operating at 100% utilization, so we have modeled that into our projected earnings model. The first model has a 22% profit margin and the second has a 25% profit margin. During the second quarter, Canyon will experience a loss due to the rainy season. It is difficult to project the second-quarter earnings due to the rainy weather described above, so we used last year's second-quarter results. Higher P/E multiples were used due to the rising awareness of Canyon's value creation as the investing community realizes that earnings will be better than what is currently expected.

Closing Thoughts

Canyon Services, like the overall energy services sector, is significantly undervalued. There is definitely a glut of natural gas in the U.S.; however, this should start to rebound with projects in the works that will export natural gas and bring some price stability to the U.S. market. That aside, the oil boom in the U.S. and Canada is still in the beginning stages of a long bull market. The demand for energy services in the near term will prove to be outpacing supply. We expect Canyon Services to be trading above $30 dollars within the next 12 months. This is a result of maintained margins and multiple expansion for the sector. Throw in a healthy dividend, with room to raise it throughout the year, and the future looks bright for this under-the-radar play on hydraulic fracturing.

Smaller energy services companies like Canyon Services and C & J Energy will provide more upside than the major energy service companies, such as Halliburton (NYSE:HAL), Schlumberger (NYSE:SLB), and Baker Hughes (NYSE:BHI), while sharing the downside.

Source: Canyon Services Group: The Undervalued And Unknown Two-Bagger From The True North