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Thesis
Energy Services of America Corporation (NASDAQ:ESOA) recently reported its most substantial revenue to date, $197 million, for the fiscal year ended September 2022. This marks the second consecutive year of revenue growth for the company, a rare feat in its 17-year history, with projections indicating that revenue will continue to increase in 2023 and 2024. ESOA comprises six subsidiary companies that offer services to various sectors, including natural gas, petroleum, water distribution, automotive, chemical, and power industries.
Two of these subsidiaries, Tri-State Paving and Ryan Construction Services, were acquired during the third and fourth quarters of 2022, respectively, and already account for 4% of the company's overall revenue. Despite the relatively recent inception of ESOA in 2006, its subsidiaries boast a combined industry experience of over 50 years. Additionally, the company redeemed all of its preferred shares in Q3 2021, which will continue to help the company reinvest that amount and create more value for common equity holders.
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Industry Analysis
The pipeline, electrical, and mechanical construction industries are characterized by their competitiveness, with exorbitant operational expenditures and fiercely contested bidding processes for contracts. The decisive elements in determining contract awards are primarily the contractor's cost and their proficiency in completing the project promptly. Thus, companies with substantial financial and human resources often hold a superior position. To that end, ESOA has substantially increased its workforce, doubling its employee count from 553 in 2020 to 1,055 in 2022.
Positive revenue outlook and good backlogs
ESOA has attained profitability on a net basis in nine of the past 10 years, doubling the net worth of its equity holders in the process. Projections estimate that the company will realize revenues of $222 million in 2023 and $230 million in 2024, with a significant portion of this growth expected to arise from new acquisitions. The company is well-positioned to achieve these projections due to its evolving revenue mix, which has allowed it to distribute its revenues nearly evenly across its various service segments - namely gas and water distribution (GWD), gas and petroleum transmission (GPT), and electrical, mechanical, and general (EMG). In the last decade, more than 80% of the company's revenue was generated by the latter two service segments. However, the currently increasing revenue share of GWD will boost ESOA's profitability, as GWD has the highest gross profit margins at 51.8% vs. 30.7% for GPT and 15.3% for EMG.
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Furthermore, there is 100% growth in the company's backlog. Now, before you start raising your eyebrows, let me explain. For construction companies, having a backlog is considered a positive as long as they are delivering their projects on time. Currently, the company has a backlog of $142M, and it will help ESOA in maintaining healthy cash flow going forward. The company hasn't been able to pay dividends regularly, though the latest one was announced last month at $0.05 per share.
On the other hand, ESOA has repeatedly announced buybacks; the latest one happened on July 7, 2022, at $1M with no expiry, which shows the solid financial position of the company. During 2022, ESOA redeemed all of its outstanding preferred shares, which was partly supported by debt. This is great news for equity holders, as this will increase their share of profits due to reduced taxes as an effect of preferred shares replaced by debt.
Investor Relations Presentation
Increased debt to the capital structure
Amid a flurry of events at ESOA in 2022, including acquisitions and redemptions, as per the most recent annual report the company has increased its total debt to $32.2 million - $17.2 million in short-term debt and $15 million in long-term debt. The short-term debt primarily constitutes a line of credit procured by the company that might alleviate its working capital requirements in the near future, yet concurrently impose additional strain on its margins and exacerbate the pressures already inflicted by long-term debt.
Despite doubling its shareholders' equity to $38.3 million in eight years, the company remains in a state of recovery from past losses, reflected in its retained earnings of -$22.2 million. While the distribution of dividends and the initiation of buybacks might not appear problematic, the combination of negative retained earnings with a negative levered free cash flow raises concerns about the company's financial stability.
Valuation
Due to the current levered free cash flows being negative and a lack of clarity over future cash flows, I prefer valuing ESOA in relation to the value of its peers. Here is my valuation based on the five-year average EV/sales of those companies:
Company Name | EV/Sales |
Argan (AGX) | 0.71 |
EMCOR Group (EME) | 0.57 |
Dycom Industries (DY) | 0.94 |
KBR (KBR) | 0.91 |
MYR Group (MYRG) | 0.49 |
Primoris Services (PRIM) | 0.53 |
Sterling Infrastructure (STRL) | 0.53 |
Average | 0.67 |
The five-year average EV/sales of ESOA is 0.25, which is almost a 63% discount to the average of its peers. Considering the margin of error and inconsistency in terms of the businesses of its peers, it's still at a 50% discount. Hence, the price of the company should be at least $2.58/50% = $5.16. Why do investors see ESOA as less attractive when compared to its peers? The answer to that is the types of services provided by ESOA. It offers services that relate to gas, water, and petroleum distribution, while most of its peers are focused on the distribution of energy and are larger in terms of revenue and manpower. And it's been said that the market awards higher valuations as a company's market cap grows, but ESOA has not yet been able to reach that level.
Risks
The company is categorized as a micro-cap stock, which means it has a low level of trading volume, with approximately 25,000 trades on average. Also, the success of ESOA's recent acquisitions has not yet been tested, and it might take up to a year or two to evaluate the outcome. Lastly, as previously mentioned, the company's increased debt might affect its cash flows and margins more than expected.
Conclusion
Stock Tracking Opinion
The recent additions to the company's portfolio not only augment its revenue, but also expand its market reach and enhance its synergistic capabilities. Despite a difficult start, marked by delisting from the NYSE in 2012, the company has demonstrated remarkable tenacity and has maintained profitability. Management has consistently delivered results and rewarded shareholders over the years. Regrettably, its stock, which was relisted only last year, has yet to be noticed by investors and analysts alike. Nevertheless, given its current price, I want to have it in my portfolio.
Investment Opinion
As per Seeking Alpha, the Wall Street rating is a strong buy while the quant rating is a hold. Based on the strengths of the company supported by my valuation, my current opinion of ESOA is that it's a buy.
Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.
