August 2021 – FTS International
FTS International (AMEX: FTSI) is one of the largest providers of hydraulic fracturing services in North America. With US investment in shale oil drilling and US rig counts still near their lows, energy stocks have been ignored. FTSI is currently cash flow positive, and having reemerged from bankruptcy protection in November of 2020, the company has zero debt, $99 million in cash, and over $300 million and $50 million of federal and state net-operating loss carryforwards, respectively. FTSI is poised to significantly grow its profits and accumulate cash on the balance sheet tax-free.
Valuation at Current Price $18
Market capitalization is $255 million, and cash of $99 million gives an enterprise value of $156 million. Management has guided 2021 EBITDA greater than $50 million, which puts the current EV/EBITDA at 4.2x. Management has mentioned on conference calls increasing the EBITDA per fully utilized fleet to $10 million in 2022, which would imply a 2022 EBITDA of $120M or 1.8x EV/EBITDA on 12 fully-utilized fleets. The company has 28 total drilling fleets and over the long-term, returning to a 20% EBITDA margin on $41 million of revenue per fleet on a conservative 22 fully utilized fleets gives EBITDA of $180 million. Note that the first $300 million of federal earnings are tax-free and will accumulate fully on the balance sheet.
FTSI is trading at a $300 million enterprise value, yet in the past has earned $200 – $400 million in EBITDA during good years. Positive industry dynamics persist, with the company achieving price increases on its utilized drilling fleets, and as the Baker Hughes US rig count increases, additional idle fleets will be required. With 28 total fleets, FTSI has significant revenue-upside as only 13 were active at the end of Q2 2021. FTSI is also a leader in dual fuel fleets with 7 Tier 2 engines that displace 50% of diesel usage with natural gas. The company recently won a contract with a major exploration and production company to develop a Tier 4 rig, which uses 75-85% natural gas, showing FTSI can capture environmentally conscious customers, while also benefitting from a higher price point than traditional rigs. Extremely low industry capital expenditures and lending risk aversion remove the chronic oversupply issues that plagued US shale in the past. The industry has been forced into extreme spending discipline, exacerbated by popular distaste for hydrocarbon energy. However, as economies open, demand for oil and gas continues to increase. High prices at the gas pump are a risk to the Biden Administration, with the president undermining his agenda by calling on OPEC to produce more oil. US shale is an obvious, local solution to high energy prices, and FTSI is in a prime position to benefit from increased fleet pricing, industry drilling activity, and consumer demand.
Green and Technology Leader
All active fleets now monitored electronically for equipment failures in real time. This eliminates mid-stage disruptions from cut valves and blown packing. MIQ is a real-time health monitoring algorithm. To our knowledge we are the only frack company with automation this advanced. Currently working on another feature to achieve design-rate faster. “Autopilot” will fully-automate ramp-up process which is typically long and costly. Allows us to complete more stages for a customer over any time period.
We have been a leader in dual fuel and have 7 dual fuel fleets in the field that are Tier 2 engines with aftermarket conversion kit. Kit can displace 50% of diesel with natural gas and we can improve further. DGB Tier 4 is 75% – 85%. We have reached an agreement with a large E&P company to build this in house and deploy in January 2022. We will recoup 2/3 of our investment in 18 months. $26M cost, half paid in cash this year and remainder in 2022. Also believe electric fleets have potential but it still feels early and not convinced benefits exceed costs.
- Customer concentration
- Any customer over 10% of revenue has a greater degree of pricing power
- Industry tightness could offset this as more fleets become utilized
- Slow Recovery / Delta Variant
- Reduced global mobility will put 2022 oil demand at risk
- Under-invested capital expenditures and consumer shift towards car travel and plastics packaging demand in ecommerce mitigates this
- Government aversion to shale
- Shale drillers already under pressure from government focus on renewable energy and bank aversion to lend
- High gasoline prices fix this. Biden administration recently asked OPEC to pump more oil. Domestic support for shale could increase as consumers punish politicians for pain at the pump
- Low volume stock
- FTSI has a small market capitalization and low volume. It may be difficult to transact.
Management has indicated returning cash to shareholders in 2022. Using just $50 million of existing cash will repurchase 16% of the company at current prices.
Energy represents less than 3% of the S&P 500 compared to 26% for technology. Should index investors demand exposure to energy there would be overwhelming flows to companies like FTSI.
Sub-industry is still somewhat fragmented, but remaining players are all well-capitalized with minimal debt and many are cashflow positive. Using debt to takeover FTSI would have one of the best IRRs available today in any asset class, even at $40 per share or higher.
Standard position size for long-term hold. Low downside with 32% of the market capitalization in cash. Multiples to upside due to significantly higher future earnings that could exceed current enterprise value. Superior setup relative to Russell 2000 and S&P 500.
Bull target: 5x fully recovered EBITDA of $180 million requires a stock price of $75. +300%
Mid-range target: 5x estimated 2022 EBITDA of $90 million requires a stock price of $40. +170%
Bear case: Temporary downside should oil industry suffer a slowdown. Cash balance limits downside.
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