FTS International (NYSE:FTSI) reported preliminary fourth-quarter results which were welcomed by investors after expectations for the operational performance have been truly depressed. I have long been attracted to FTS following its IPO and while the dip-buying might have been ill-timed and too early, I am still happy to hold onto a substantial long position which I have averaged down to $10.
This comes as the earnings yield remains compelling, potentially translating into even greater cash flow power in case oil prices might really show a recovery from here.
FTS International announced that it sees fourth-quarter sales at $245-250 million. On these sales it sees EBITDA at $62-64 million and net earnings of $25-27 million. Cash flow conversion is better with fourth-quarter capital spending seen at just $16 million, while depreciation expenses come in at $22 million. The solid cash flow generation made that gross debt has been cut to $508 million by the end of the year, with net debt standing at $330 million.
The company exited the quarter with 19 active fleets, with average fleets coming in at 19.3 for the quarter, down from 21.8 in the third quarter. Market turmoil and correlated to that lower oil prices have been weighing on the results, as capital spending budgets of many E&P names have been exhausted towards the end of the year.
FTSI's CEO Michael Doss has indicated that higher oil price volatility has caused uncertainty for the outlook for frac demand in the first half of 2019, as E&P companies will prioritise capital spending, creating little visibility for the quarters to come.
On the bright side is the expectation that one or two additional fleets will be deployed in the first quarter. This good news, that of a sequential increase in activity levels, will not be seen on the bottom line. This comes as pricing pressure is seen which lowers annualised adjusted EBITDA per fleet, although the company has not quantified this impact.
At the end of October, FTSI reported third-quarter results as the company reported revenues of $334 million for the quarter, down from $493 million in the second quarter. That implies that the company has seen revenues being cut in half, in the time frame of just six months. Given the declines, the results on the bottom line are holding up still relatively nicely, if you ask me.
The 109 million shares traded at $8 ahead of the report, for an $872 million market valuation. Including $330 million in net debt, the company is awarded a $1.2 billion valuation. The issue is that trends have been dismal and even as earnings have come down, it has allowed for significant deleveraging. Even based on Q4 EBITDA of $63 million, leverage ratios remain modest at 1.3 times (if we annualise the weak Q4 numbers).
With net income still trending at $100 million a year, that still works down to earnings power of nearly one dollar per share, for an earnings multiple of 9 times. In comparison, the company reported net earnings of $232 million in the first nine months of the year, as trends have been really painful to watch.
Reality is that crude continues to trade just in the low-$50s, which marks a big retreat from levels as high as $80 in September. This is the reason why the company has seen such a painful deterioration in the results from its operations.
This is the reason why sales and earnings are plunging, yet even after sales are cut in half already over the past six months, with earnings down by even greater percentages, multiples remain very modest. After all, a 1.3 times leverage ratio is not too high given the dismal operating conditions of the industry, and earnings power remains solid.
Furthermore, the company has a huge capacity with 1.7 million HPP or 34 fleet with utilisation currently standing at just 56%. These low utilisation rates have hurt pricing as well, although margins are still better than the period 2015-2016 as oil prices collapsed to a low of $25 at the time. The company, furthermore, claims that new capacity is not expected to come online quickly as the company has a cost advantage, thanks to an integrated business model, and the fact that 50k HHP replacement comes at a cost of $25 million currently.
This suggests that the replacement value of the fleet comes in at $1.7 billion, substantially more than the current valuation of the business (even including debt).
This observation and an effective tax shield provided by net operating losses (thanks to large losses in the past) make that cash flow generation remains healthy, with net debt continuing to come down despite sub-optimal earnings. Furthermore, valuations are not demanding in my eyes, although capital spending would likely increase substantially if a sustainable recovery kicks in following higher oil prices. Net debt has come down from nearly $1.1 billion early 2017 to little over $300 million currently, as little over half of the deleveraging has come from the IPO proceeds as the remainder comes from operational cash flows.
The company actually goes on to say that the valuation of the business is underestimated by the market as management points towards the huge tax assets as well as the value of the in-house manufacturing services, implying just a very modest valuation of the operating assets.
While the jump in the share price to $9 following the latest numbers is very much welcomed, with my average cost now down to $10, and shares recently trading at $6 and change, I am still very happy to hold onto my position waiting for better days as the worst might just have been over.
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Disclosure: I am/we are long FTSI. 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.