I had large moves over the last couple of days in 2 stocks that I own, Leader Energy Services and Prophecy Coal. I want to talk about one of them, Leader Energy Services (lea.v), in more detail in this post.
To be perfectly honest I’ve been pissed off with myself for buying as much of this stock as I did. Its affected my decision making in other stocks and that has cost me. Because I didn’t want to be too leveraged to the Oil Services sector, owning so much of Leader has kept me from feeling comfortable holding on to Open Range. When the market looked like it was going to tank because of Europe, I went to lighten up on some stocks. Because Leader was illiquid, it was difficult to sell without cratering the share price. Open Range has lots of liquidity, so rightly or wrongly I dropped Open Range and held onto Leader.
Well now Open Range is almost $7 and Leader was, until Friday, languishing under a $1. I had clearly made a bad choice and it was discouraging. Fortunately Friday’s move of 20% in the stock helped wipe away some of those frustrations.
Leader is the small (~$20M market cap, $35M EV), illiquid little stock of a oil services company located here in Calgary.
The Oil Services Leader Provides
Leader provides the following services:
- Coiled Tubing: you put coiled tubing down the well generally with the intent of pumping some sort of fluid thru the tubing down into the wellbore. There are a whole bunch of reasons you might do this, and they are actually described in good detail on wikipedia. Calfrac also has a good description.
- Nitrogen Services: One of the reasons you put coiled tubing downhole is to pump a fluid down. Nitrogen is sometimes pumped down to either flush out unwanted materials trapped in the wellbore or to lighten the fluid coming out of the formation, making it easier to flow more readily.
- Fluid Pumping Services: This really goes part and parcel with the tubing. After you have injected the coiled tubing, you need a pump to get the fluid down the hole
The coiled tubing operations are more and more in demand. Raymond James recently described the market as extremely tight. The tightness is also mentioned anecdotally here , here and here. Xtreme coil explained the usage in horizontal multi-frac wells succinctly with this snipit from their Q1 release:
“[There is] robust demand for coiled tubing services, especially in developing complex resource plays where long horizontal wells are the norm. Since these wells are completed with multiple-stage fracture treatments, they require cleaning out after all the stages of treatment are completed. The application of coiled tubing can dramatically improve the outcome of this complicated work scope.”
A Growing Business
Leader has been growing their business. Below is the quarterly EBITDA for the company for the past 3 years. Note that the cyclical nature of drilling in Alberta (spring break-up) always leads to a weak second quarter, but ignorning that the trend is clearly bottom left to upper right.
Margins have held up well too. Below is gross margins over the same period.
Too Much Debt
The biggest problem that Leader has is the amount of debt on its balance sheet. There is about $14M in debt right now, which compares to a company Enterprise Value of $31M, making the company fairly leveraged, particularly for a tiny company in a cyclical business.
I think this is why the stock performs so poorly every time there is a worry about European debt. When you have a lot of debt you are a slave to the underpinnings of the debt market. I have heard the company expects to devote cash in 2011 to reducing the debt load. I think this is a good idea; investors will be a lot more confident in the long term performance of the stock if it isn’t so leveraged.
The debt load used to be worse. Going into 2008 the company have over $31M in debt. This was obviously not a great position to be in when the debt markets seized up. To deal with the problem at the time they had to issues convertibles at a low price and restructure and it got messy. Hopefully Leader has learned their lesson that debt is ok if its done in moderation. The commitment to using free cash to reduce debt instead of to fund growth suggests they have.
And they should be able to reduce debt quite quickly. Leader had operating cashflow of about $6M in 2010. They generate $4.5M of operating cashflow in Q1 alone. By the end of the year they should be able to make a good sized dint in their long term debt.
Leader compares well to its peers. Below I have provided a comparison I did a while ago of a number of the oil services companies that (in most cases) specialize in coiled tubing and/or pressure pumping. You can see that Leader is at a discount to most of them.
For all the EBITDA calculations I tried to ex-out any one time charges or non-operating effects. Note that of the above companies that are listed, that Technicoil Group was taken over by Essential and so the stock price is TEC is as of the takeover date. Open Range is difficult to value because of the natural gas business, so I used Canaccord’s EBITDA estimate for Poseiden (the name of Open Range’s services business) for 2011, and I subtracted a simple $40,000/boe flowing using the 2011 estimate of production to ex out the exploration business).
Dalmac is the only company cheaper than Leader. They might be worth a look themselves.
There is a pretty decent report put out by some firm called eresearch that has a similar comparison done.
So I guess that my investment thesis is two-fold. The company is undervalued compared to its peers, and I suspect that valuation gap will close as the company brings down its debt. Second, as the company pays down debt that enterprise value should move from the debt into equity. And third, the company is in a business that is experiencing growing demand and so margins should stay high for at least the short and medium term, allowing the company to generate a lot of cash and potentially begin to grow their business in 2012 once the debt load has been reduced. The stock has been slower to move than many of its larger peers that have brokerage attention (ie. Open Range), but hopefully Friday’s move is evidence that the move is upon us.