Adams Resources & Energy: An Asymmetrical Bet On Crude Oil Prices

Feb. 19, 2021 9:58 AM ETAdams Resources & Energy, Inc. (AE)4 Comments1 Like

Summary

  • Improving outlook for oil prices dictate Adams Resources as a great play for post-COVID vaccinations.
  • Several new management appointments indicate a vastly experienced team at the helm of the ship leading the charge.
  • Two accretive acquisitions boast newly appointed management's ability to pivot the company's growth and share price.
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Adams Resources & Energy Inc. (NYSE:AE) is a play on the improving crude oil price outlook. The recent pipeline acquisition establishes company's presence in the midstream value chain in the attractive Gulf Coast region. The leadership changes made over the last 12 months or so are starting to yield results. Initiate with BUY rating and a $39.75 price target.

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Investment Thesis

  • Adams Resources & Energy Inc. is a play on the improving outlook for crude oil prices as vaccine rollouts increases optimism on global economic recovery.
  • We believe both AE's businesses, supported by two recent acquisitions, are well-positioned for growth heading into 2021.
  • The recent acquisition of VEX Pipeline System will strengthen the GulfMark business in the Eagle Ford and Gulf Coast region. It also provides company with a presence in the midstream value chain in the attractive Gulf Coast market.
  • We are also upbeat on AE's acquisition of CTL Transport which increases the size of Service Transport's fleet by more than 50%.
  • EIA expects Brent crude oil prices to average $53/bbl in both 2021 and 2022 supported by OPEC production cuts.
  • We initiate coverage with a BUY rating and a price target of $39.75, implying a capital appreciation potential of ~52%.

Primary Risks

  • A potential fall in crude oil prices could lead to lower production and adversely impact its crude oil transportation and marketing operations.
  • Failure to successfully integrate acquisitions could adversely impact business operations

Investment Thesis

Adams Resources & Energy, Inc. is primarily engaged in the business of crude oil marketing, transportation and storage and tank truck transportation of liquid chemicals and dry bulk through its two wholly-owned subsidiaries GulfMark Energy, Inc. and Service Transport Company. We believe both AE's businesses, supported by two recent acquisitions, are well-positioned for growth heading into 2021, despite continued market volatility as a result of the ongoing pandemic.

The recent acquisition of VEX Pipeline System will strengthen the GulfMark business in the Eagle Ford and Gulf Coast region. It also provides the company with a presence in the midstream value chain in the attractive Gulf Coast market. Crude oil prices are expected to remain firm in 2021 which should benefit GulfMark's operations.

The acquisition of CTL Transport, completed last year in June, has strengthened the Service Transport business by increasing the size of its collective fleet of both tractors and trailers by more than 50%, as well as expanding its operating footprint into five new important markets. Also, the transaction is immediately accretive to earnings.

Last year, GulfMark Energy brought in new leadership headed by Mr. Greg Mills as the President. He brings in significant experience in midstream business as well as crude oil marketing and related operations. With new leadership and key pipeline acquisition in place, the Adams Resources & Energy subsidiary looks well positioned for growth in 2021.

We initiate coverage with a BUY rating and a $39.75 price target.

GulfMark business showing strength; Recent M&A to further boost

GulfMark saw improved topline in Q320 driven by a 12% increase in marketed volumes along with strengthening crude pricing sequentially (versus Q220). GulfMark's business is also benefitting from the cost and operational efficiency initiatives put in place in H1 2020 to help offset the impact of reduced crude oil demand amid the COVID-19 pandemic.

We are also excited about GulfMark's recently completed acquisition of the VEX Pipeline System. This will strengthen the GulfMark business in the Eagle Ford and Gulf Coast region. The strategically located VEX pipeline connects the heart of the Eagle Ford Basin to the Gulf Coast waterborne market through two terminals in Cuero and the Port of Victoria, Texas. The acquisition provides GulfMark with an additional 350,000 barrels of above-ground storage, two eight-bay truck offload stations, and access to two docks at the Port of Victoria. The VEX system boasts a current capacity of 90,000 barrels per day.

The pipeline can receive crude oil by pipeline as well as by truck, and the potential for further downstream connection opportunities beyond the two existing terminals. The acquisition significantly enhances GulfMark's position at the Port of Victoria, where it now controls 450,000 barrels of storage with three docks.

VEX acquisition supports one of AE's key areas of focus, the Texas/Louisiana Gulf Coast and gives GulfMark control of the VEX pipeline and terminal assets This will open growth opportunities for current GulfMark business since the company now will be more involved with the midstream value chain for crude oil and condensate production moving from the wellhead to the end market. AE will now be able to provide high-quality midstream services to producers and marketers in the Eagle Ford area.

We note that AE acquired the VEX system from EnLink (ENLC) for only $20 million ($10 million cash plus $10 million via financing). This compared with EnLink's purchase of VEX system from Devon Energy (DVN) for around $220 million in 2015.

The company expects the VEX acquisition to continue to pay dividends. Greg Mills, President of GulfMark Energy, noted that the goal is to bring in shippers who want to use the VEX Pipeline System to move oil, thereby creating a new revenue stream for the company. CEO Kevin Roycraft is bullish on the pipeline prospects as it will provide access to potential new customers, including companies like Max Midstream Texas, which is looking to establish a new overseas shipping export dock outside of Houston.

Crude oil prices to remain firm in 2021 and 2022

Crude oil prices are expected to remain firm in 2021 as the rollout of vaccines and fiscal stimulus programs should result in stronger-than-expected global economic recovery from the pandemic. The IMF expects global GDP to grow 5.5% in 2021, after a 3.5% contraction in 2020. Crude oil has risen steadily since late last year as coronavirus vaccines and supply curbs from OPEC spur hopes that global inventories will continue to slide. Further, optimism over a speedier US economic recovery on the prospect of additional stimulus from the Biden administration and a successful rollout of the U.S. vaccination program is aiding prices.

EIA expects Brent crude oil prices to average $53/bbl in both 2021 and 2022. Saudi Arabia's unilateral cut means global oil market balances will be tighter in early 2021 than previously expected. EIA expects global oil inventories will fall by 2.3 million b/d in the first quarter of 2021, which EIA expects will contribute to Brent prices averaging $56/bbl.

With cold weather sweeping across the U.S., there could be higher inventory draws which should support prices to continue to surge higher. However, near-term concerns about new virus variants and slower-than-expected vaccine rollouts globally could keep the volatility high.

Exhibit 1: WTI Crude Oil Price to remain above $50/bbl

Source: EIA and Singular Research

GulfMark endures crude oil downturn; Well positioned for 2021

GulfMark's primary business involves buying crude oil, transporting it and selling it. GulfMark operates in Texas, Louisiana, Oklahoma, North Dakota, Michigan and Ohio, with facilities or assets including 260 tractor-trailer rigs and maintains 164 pipeline inventory locations and injection stations. It marketed ~90,896 bpd during Q3 2020, compared to 105,801 during Q3 2019.

GulfMark's business model has shown high resiliency during the pandemic. Despite steep decline in crude prices as well demand drop during the first half of 2020, GulfMark has remained profitable. With vaccinations beginning in many parts of the world, the signs of recovery are visible. The crude oil prices have firmed up and there is pickup in demand as well. This positions the business for strong growth prospects in 2021.

Additionally, GulfMark's superior service provides it with significant competitive advantage over many less efficient trucking companies. Its transportation fleet and drivers are best in class, with respect to timeliness and ratability, safety metrics, and overall performance. In fact, GulfMark's safety record is so sound that it was able to reduce its planned accrual for insurance expenses in 2020.

Exhibit 2: GulfMark Seeing Signs of Recovery

Source: Adams Resources & Energy and Singular Research

CTL Transport acquisition to bolster Service Transport Business

Service Transport acquired CTL Transportation in May 2020. CTL is a liquid bulk chemical carrier that owns approximately 160 tractor trailer trucks and 320 trailers with primary operations in Alabama, Florida, Georgia, Louisiana, Missouri, Ohio and Texas.

The acquisition increased the size of Service Transport's collective fleet of both tractors and trailers by more than 50%, as well as expanded its operating footprint into four new important markets. Also, the transaction is immediately accretive to earnings.

The acquisition added approximately 150 drivers and 320 trailers to the company's existing fleet. The acquisition grew Service Transport's existing bases in the Freeport TX and Mobile AL areas, and St Gabriel LA, and provided entry in new locations - Atlanta GA, Cincinnati OH, Jacksonville FL, Tampa FL and Sterlington LA.

We believe that post the CTL acquisition Service Transport boasts of much larger industry-leading vehicle fleet and operating footprint, along with an expanded pool of best-in-class drivers and support staff. This positions Service Transport in a strong position for continued long-term success.

The integration of the assets of CTL Transportation into Service Transport's business has gone very well as evident from Q3 2020 results. Service Transport delivered sequential Q3 2020 revenue growth of almost 80%.

Management change at its two subsidiaries

AE appointed new management team at GulfMark Energy to boost its growth prospects. Mr. Greg Mills was appointed as President of GulfMark Energy Inc. in March 2020. He has over 20 years of experience in the midstream marketing, asset management and business development. Prior to GulfMark, he spent two years as executive vice president of Energy Transfer's commercial business in charge of crude oil assets; and 19 years with Enterprise Products in various roles, including VP of crude oil pipelines and terminals.

At Energy Transfer Partners, he was responsible for a multi-billion-dollar crude oil business spanning the Dakotas, Oklahoma, Texas, Midwest and Gulf Coast. He also led the successful acquisition of SemGroup Corp by Energy Transfer in 2019.

Last year in January 2020, AE appointed Wade Harrison as the new President of Service Transport business. He has 17 years of experience in transportation and logistics operations, management and leadership. Prior to that in November 2019, AE appointed Kevin Roycraft as its CEO.

We think the leadership changes have been positive for the company as evident in its strong Q3 results despite the pandemic.

Management and shareholders

The company is led by CEO Kevin Roycraft who was appointed in this position in January 2020. Prior to joining AE, Mr. Roycraft served as Executive Vice President for Dana Transport Inc. from January 2016 through November 2017. AE also appointed Mr. Greg Mills as the new President for its subsidiary, GulfMark Energy Inc. in March 2020. He has a strong record of leading midstream companies as well as crude oil marketing and related operations. On its most recent earning press release, the company reported ~4.2 million shares outstanding. A summary of key shareholdings follows.

Exhibit 3: Key Shareholdings - Insiders and Institutions

Source: Adams Resources & Energy and Singular Research

Q320 Financial Results:

AE reported a year on year increase in net income for Q3 2020. It generated a net income of $3.1 million in Q320 versus $0.6 million in Q3 2019. However, revenue was still down at $266.9 million in Q320 versus $450.3 million in Q319 as COVID-19 continued to weigh on crude oil price as well as demand. Crude oil marketing accounted for 92% of revenues and continues to be the core business for the company. Crude oil marketing revenue stood at $245.1 million, down 44% versus $434.6 million in Q319. The transportation segment accounted for the remaining 8% of revenue and generated sales of $21.7 million, up 38% YOY driven by CTL Transport acquisition which was completed during Q220.

AE's both subsidiaries - GulfMark Energy Inc. and Service Transport Inc. - posted sequential improvement in results in Q320. GulfMark saw improved topline driven by a 12% increase in marketed volumes along with strengthening crude pricing versus Q220. GulfMark marketed 90,896 bpd of crude oil during Q320, compared to 105,801 bpd during Q319 and 81,152 bpd during Q220. GulfMark held 411,380 barrels of crude oil inventory at September 30, 2020, compared to 519,927 barrels at June 30, 2020.

Service Transport saw sequential quarterly revenue growth of almost 80% driven by the purchase of assets from CTL Transportation.

The company was able to reduce overall expenses for Q320. The marketing expenses was down 45% YOY to $237.4 million and SG&A expenses was down 48% YOY to $1.4 million. AE saw significant improvement in adjusted cash flow during Q320. The adjusted cash flow was $10.3 million for Q320, versus $6.5 million for Q319.

EPS guidance and estimates

The pick-up in crude oil prices as well signs of global economic recovery position the company for solid growth in 2021 and 2022. The company benefits from strength in crude oil prices which has risen sharply since the lows of April 2020. Additionally, the recent pipeline acquisition bolsters AE's presence in the midstream value chain in the Gulf Coast region. The company's Q320 results also suggested momentum in the business picking up.

For full year 2020, we expect revenue of $1,083 million, down 40.2% YOY. For FY 2021, we forecast revenue of $1,346 million, up 24.2% YOY. We expect operating profit of $11.5 million in 2021. This should result in net income of $9.3 million and EPS of $2.17.

We expect AE to deliver revenue of $1,413 million for 2022 and net income of $10.5 million. This results in earnings per share of $2.47 for 2022.

Investment risks

  • AE is highly exposed to crude oil price volatility. The prices depend on many factors including changes in supply and demand, the economy, weather, inventory levels, pipeline capacity, government regulation and taxes, and the worldwide political climate. A potential fall in crude oil prices could lead lower production and adversely impact its crude oil transportation and marketing operations.
  • The company depends on the continuous and smooth functioning of the economy. Any further shutdowns or shelter-in-place restriction due to COVID-19 could impact operations.
  • The company has been undertaking an aggressive M&A strategy. Failure to successfully integrate acquisitions could adversely impact business operations.

Valuation

We value AE using industry peer companies (P/B, P/E multiple) blended with our Discounted Cash Flow (DCF) valuation to derive a fair value target price for the company.

We are valuing AE using a combination of P/B and P/E multiple. AE trades at ~0.8x price to book compared to ~1.49x for the peer group average. Given its long-established relationships with customers, industry leading safety record and presence in attractive Gulf Coast region, we believe the discount should narrow. We value AE at 1.1x our 2022 BV per share estimate of $39.18 and 17.1x our 2022 EPS estimate of $2.47. We weight this discounted multiple target to equal 50% of our price target. The multiple based target price is $43.00, which discounts back to $34.28.

We weight the other 50% of our target using our Discounted Cash Flow target. Our DCF model uses our forecasted free cash flow to the firm over two years, and then grows EBIT at a 4.5% rate over years 3-8. We apply a weighted average cost of capital of ~12%. Our DCF produces a value of $45.23.

The combination of $34.28 at 50% and $45.23 at 50% results in a weighted average price target of $39.75.

Exhibit 4: Adams Resources & Energy Inc. Peer Group Multiples and Price Targets

Source: Adams Resources & Energy and Singular Research

The Exhibit below shows stock price targets using various combinations of EPS and P/E multiples. Our earnings per share estimates for 2021 and 2022 are $2.19 and $2.50, respectively. The unshaded portion of the chart shows resulting stock price targets at various forward P/E multiples above the current price of $26.21 as of February 5, 2021.

Exhibit 5: Forward P/E Ratio Vs. Forward EPS

Source: Singular Research Estimates

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Disclosure: I am/we are long AE. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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