Profire Banks On Diversification Strategy In The Medium Term
Summary
- Increased adoption of PF3100 and its expanded applications to non-energy uses are underway in 2021.
- PFIE plans to accelerate diversification into the aerospace, power generation, and industrial and chemical processing industries.
- The weather-related turmoil in Texas is likely to affect the company's Q1 performance adversely.
- It has no debt; however, negative free cash flow can become a concern.
PFIE's Medium-Term Investment Horizon
Profire Energy's (NASDAQ:PFIE) management has become relatively bullish in recent times as the crude oil price stabilizes and drilled and completed well counts have gone up. In Marcellus and Utica, the company's sales are on an uptrend. It is also making efforts to diversify into the renewable energy market and the midstream & downstream markets through its PF3100 burner management system.
The primary concerns relate to the potential demand loss due to another potential COVID outbreak and the company's steeply falling cash flows. However, because of zero debt and the liquidity balance, the stock has an inherent advantage over the competitors. I do not think the stock price will go up in the short term. Medium-to-long-term investors can consider holding it for future gains.
The Outlook Brightens
At the start of this year, PFIE's management is optimistic of an energy market rebound. Many analysts have raised the short-term crude oil price target to $70. Simultaneously, some of the economic indicators have improved after the vaccine roll-out. If the crude oil price stays above the expectation level, many upstream producers will likely increase energy production, leading to positive cash flow generation. This can free up the capex budget in FY2021. However, despite the improvement in sentiment, PFIE may have to grapple with the fact that the U.S shale production will remain flat or potentially decrease, while the drilling and completions are expected to be limited and may end up below the pre-pandemic level.
PFIE's flagship PF2100 crude oil burner management system has seen enhanced adoption, leading to repeat orders in Q4 2020. Investors may note that PF2100 emphasizes on efficiency, safety, and compliance aspects of drilling. Read more about the company's strategies in my previous article. Eventually, PF2200 will replace PF2100 in atmospheric, upstream, and midstream applications.
The company's PF3100 product, on the other hand, enables its diversification strategy in the upstream and midstream space. The product had seen a slow turnover in the first half of the year because the energy demand collapsed and the refineries and petrochemical plants deferred project plans. However, in Q4, half of these projects, including frac water heaters, higher spec incineration equipment, and multi-burner process heaters, started installing the application of PF3100.
Strategic Diversification
PFIE now looks to complete installations in agriculture, aviation, renewables, construction, and infrastructure as part of its diversification strategy. Moving beyond traditional energy, it has recently partnered with a clean energy solutions provider for hydrogen-fueled vehicles. During Q4, it started discussing with a customer regarding a critical thermal appliance upgrading, a potential new market. In the industrial market, it can provide a specialized OEM with the burner management system requirement. So, the entry can mark its way into the aerospace, power generation, and industrial and chemical processing industries.
Geographically, PFIE generated most of its Q4 sales from the northeast part of the country, including the Marcellus and Utica. It also secured strong growth in Canada during the quarter. In March 2021, it signed a distribution agreement with Spartan Controls Ltd. By which Spartan will strengthen its sales of the industrial combustion products in Western Canada. The cold weather, sales related to deferred maintenance, and deferred retrofits piled up in Q4. I think the company will continue to benefit from this trend in the near term.
On the other hand, its sales in the DJ Basin and the Balkan were quiet, which may continue in Q1 2021 also. While its sales in South Texas had a bump in Q4, I think it can decline sharply in Q1 due to the inclement weather at the start of this year. Overall, the company will focus on growing its existing burner management with the core legacy solutions into upstream and midstream markets. The medium-to-long-term will cater to the downstream distribution pipeline, transmission segments, and the renewable energy market.
Some Drivers Weakened In February
In the past year, drilled but uncompleted wells (or DUC) (7% down) have been marginally weak until February 2021, according to the EIA's latest Drilling Productivity Report. The drilled wells and the completed wells, in comparison, declined much sharply (63% and 55% down, respectively) during the same period. However, led by higher West Texas Intermediate (or WTI) crude oil price since July, the drilled and completed wells count recovered until January 2021, suggesting that an energy recovery was well underway.
According to Primary Vision, the frac spread count, which slipped to a low of 41 in February before bouncing back to 200 - a one-year high - by the end of March. The weather-related turmoil in Texas did affect the energy activity in February and is likely to affect the company's Q1 performance adversely. Nonetheless, the medium-term outlook is a lot more prominent than six months ago.
CAD-to-USD Movement
PFIE is exposed to the U.S. dollar to the Canadian dollar (or CAD-USD) exchange rate risk. Crude oil has a negative correlation with USD/CAD. Since the beginning of 2021 (i.e., January 1), the WTI crude oil price has increased by 25%, while USD has depreciated marginally versus the Canadian dollar. Investors may note that appreciation in the Canadian dollar relative to USD is beneficial to the Canadian oil producers and the OFS companies like PFIE.
Understanding The Recent Drivers
In Q4 2020, PFIE's revenues increased by ~41% compared to Q3 2020. Year-over-year, however, it was still down by 95% in Q4. Despite the pandemic-related sales loss over the past year, its customers increased capex at the year-end led by the stabilized political environment and positive news regarding the pandemic recovery efforts.
The gross profit margin, too, reflected the recovery as it expanded to 49.1% compared to 37.5% a quarter earlier. The improvement was driven by better product mix and higher coverage of fixed cost or fixed cost absorption. Also, lower operating costs following the pandemic's outbreak led to a sharp EBITDA margin recovery in Q4. The adjusted net profit for Q4 was $0.02, which was a turnaround compared to a $0.02 loss per share in Q2.
Zero Debt, But Cash Flows Fell
In FY2020, Profire's cash flow from operations (or CFO) was minuscule (less than $1 million) compared to $7.7 million a year ago. Led by a 45% fall in revenues in this period, deterioration in working capital led to the CFO fall. As a result, the company's free cash flow (CFO less capex and acquisitions) dropped by 83% in FY2020.
PFIE is a zero-debt company. The company's cash and cash equivalents (includes investments) were $17.6 million on December 31, 2020. The management believes that its inventory level is sufficient to address any possible rise in orders in the short term. Although the company does not have many financial risks, it might want to improve free cash flows to avoid any possible strain on the balance sheet in the current scenario.
The company's executive officers, directors, and a handful of shareholders have ~33% ownership. So, the insiders can influence capital events, including M&As and dividend-related decisions.
Linear Regression Based Forecast
I have observed a regression equation based on the historical relationship among the crude oil price, U.S. completed wells count, and PFIE's reported revenues for the past five years and the previous eight-quarter trend. Based on the model, I expect revenues to decline in the next 12-months (or NTM). It can recover in 2022 and grow at a modest rate afterward.
In the Monte Carlo simulation, after 10,000 iterations, I find that the maximum frequency ranges between $22 million and $45 million. The trailing-12-month (or TTM) revenue falls at the lower end of this range. Investors, however, should note that this is only an academic exercise.
Based on a simple regression model using the average forecast revenues, I expect the company's EBITDA to deteriorate in the next 12 months (or NTM) 2021. I expect the loss to lessen in 2022 but will stay EBITDA negative in the following years.
I have calculated the EV using PFIE's forward EV/Revenue multiple (because EBITDA is expected to remain negative, the EV/EBITDA multiple does not produce any meaningful result.) Returns potential using the forward multiple (1.84x) is much lower (16% downside) compared to the sell-side analysts' expected returns (~93% upside) from the stock. I think the sell-side analysts are overly bullish about the stock. It has a mildly negative bias in the short term.
What's The Take On PFIE?
After the revenue loss following COVID-19, PFIE's sales turned around in Q4 due to higher sales in the Marcellus and Utica. Some industry indicators, including the crude oil price and drilled and completed well counts, have become relatively bullish. While its PF2100 crude oil burner management system saw enhanced adoption in Q4, a more prominent driving force came through due to its diversification in the downstream distribution pipeline, transmission segments, and the renewable energy market.
However, the uncertainty around energy demand persists, and the virus rears up its head once again in the summer. Given the headwinds in the traditional energy markets, the company is rolling out the burner management systems' application in alternative uses. In 2020, the company had been free cash flow negative. So, in the past year, the stock underperformed the VanEck Vectors Oil Services ETF (OIH). Although the stock price may not offer much upside, I think medium-to-long-term investors can expect gains from the stock.
This article was written by
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