I liked Basic Energy Services (NYSE:BAS) back in October, but even I didn't think the shares were going to snap back this strongly. Competition remains fierce in basins like the Permian and activity levels weren't great in the fourth quarter, but Basic Energy has done a good job of controlling costs while adding assets in its fluid services business.
It looks as though energy companies are getting an early start to their 2014 capex plans, and pricing is improving as a result. Valuation for small service companies is frustratingly imprecise, but I wouldn't rule out the possibility of EBITDA estimates moving up throughout the year. For now, though, I think some of the excitement in the shares can be explained a reaction to some very loudly bearish analysts and a large short position, and I'd probably wait for the dust to settle a bit before buying.
Q4 Not As Bad As Feared
As Basic Energy updates investors every month on utilization metrics, there really isn't much cause for the revenue portion of earnings releases to be a big surprise. In the case of Basic Energy, though, there was a lot of negativity out there on the company's probable margins for the quarter (due to difficult pricing in many basins) and guidance for the next year.
As it turns out, Basic Energy did pretty well. Revenue was down 5% sequentially, with Completion revenue down 3%, Well Servicing down 14%, and Fluid up 2%. Most utilization metrics were flat or down, as Well Servicing rig utilization fell to 65.6% (from 74.7% in Q3) and revenue per truck was flat in Fluid.
I don't disagree that Q4 (and all of 2013, really) was tough, but Basic Energy did okay on margins. Gross margin was basically flat, while EBITDA declined in pace with revenue (down 5%). That was good for a roughly 6% beat versus the sell-side expectations.
Will 2014 Be Better? It's Looking Like It Could Happen...
Amidst ongoing concerns about capacity in fracking, well servicing, completion, and fluid services, Basic's outlook for 2014 sounded relatively upbeat. Management noted that E&P companies are getting off to an earlier start this year and guided revenue up a couple million dollars versus the old average sell-side estimate. Pricing also seems to be firming up as more service companies act a little more responsibly.
With Basic Energy management seeing signs of emerging/growing demand, they have elected to add $50 million to the capital spending budget (from $165 million to $215 million). The company has been busy recently adding fluid service trucks and disposal wells, owning more than 1,000 of the former and 81 of the latter. That makes the company an even more formidable competitor with Key Energy (NYSE:KEG) and Nabors (NYSE:NBR) (with about 1,000 and 900 trucks, respectively, as of last reporting) in what is becoming an increasingly monitored part of the drilling process.
In terms of where Basic Energy might look to grow, it sounds like management is basically happy with its pressure pumping capacity. They have spoken before of wanting to bulk up the cementing and acid businesses, so that would seem like a logical enough expectation.
Will Market Growth Offset Commoditization?
I don't want to seem like I'm casting aspersions on Basic Energy's business, but it is important to understand what it is and what it is not. Basic Energy does not challenge companies like Schlumberger (NYSE:SLB) in high-value areas like reservoir characterization or wireline services. In the areas where Basic Energy does compete, like coiled tubing, fishing/rental, and fluid services, there is ample competition from Key, Nabors, Superior (NYSE:SPN), and sometimes the Big Three as well. Likewise, Basic's fracking business isn't focused on the horizontal wells that are increasingly important in areas like the Permian and Eagle Ford, but rather focuses on low-HP, low-complexity vertical well projects.
Basic Energy does not offer unique high-value services, but that does not mean that its services are not necessary. There were almost 800 permits issued for Permian wells in January alone, and companies like Anadarko (NYSE:APC) and Apache (NYSE:APA), both of which are Basic Energy customers, are moving ahead with dispatch. As more wells are drilled in Texas and other oil-producing regions like Ark-La-Tex, demand for rental/fishing, coiled tubing, fluid services, completion, and workover will continue to increase.
There are threats to the business, as producers look at alternatives like greater on-site wastewater recycling, but this is a utilization-driven model. If initial trends for 2014 continue, Basic Energy should see better workover rig utilization and better utilization of its fluid trucks and frac tanks. As utilization improves (for example, as worker rig utilization goes back over 70% or 75%), the margins start improving rapidly.
The Bottom Line
I do expect EBITDA estimates to head higher after this quarter, and it would not surprise me if estimates ultimately move from around $285 million today to a range of $320 million to $340 million. That doesn't necessarily make valuation any easier, though. With improving market conditions, I think a 5x multiple to EBITDA would be reasonable (if not somewhat conservative), but EV/EBITDA is a frustratingly imprecise method and one that is extremely sensitive to relatively small changes in the multiple.
I think Basic Energy's fair value lies around $20 today on the basis of that 5x multiple and my expectations for 2014 EBITDA. That doesn't make these shares all that appealing now given where they are trading, but I would not be surprised to see upside to both EBITDA and multiples this year. What's more, I do believe the shares are getting pushed up by short-covering - Yahoo! Finance reports nearly 23% of the float held short as of the end of January and there have been some very bearish analysts out there.
Considering all of the above, I'd be careful about rushing into these shares now. I do like Basic Energy and I do think 2014 will be a better year for smaller service providers. I would just let the dust settle a bit and maybe hope to pick up shares at a less demanding multiple/valuation.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.