In a previous article about the most beneficial stocks for the new year, I said
Although deep value stocks – as represented by miners and oil and gas producers – have seen a losing streak against growth stocks, the tide has turned since the Covid-19 low. in March 2020. I think this change is just the beginning of a commodity super cycle. Thanks to the prolonged bear market before this turnaround, mining and energy stocks are still incredibly cheap despite their recent strength.
Many smart investors are moving from overvalued tech stocks to oil stocks – one of the biggest value depressions in today’s market. But when you look at the oil industry, you realize that something never changes in the oil sector. Upstream producers are still scrambling to increase capital spending, as the painful oil crash fades from memory and with Wall Street rolling on.
This time will be no different. Oil consultancy Rystad Energy predicts overall oil and gas investment will rise 4.3% from $602 billion in 2021 to $628 billion this year, fueled by a 13.7% rise upstream investments in gas and LNG and a 7.0% increase in upstream oil investments, offset by a 6.7% decline in midstream and downstream investments (Fig. 1).
This, of course, is music to the ears of one segment of the petroleum industry – petroleum service providers (or OFS), who provide all petroleum equipment and services used for the exploration and production process ( E&P) in the upstream sector. Indeed, the capital expenditures of oil companies are revenues for SFO providers. As oil companies spend more money on upstream projects, OFS companies will see explosive growth in revenue and profit. Therefore, OFS stocks typically outperform average oil stocks in the second half of the bull cycle.
Therefore, smart investors should consider increasing their exposure to the OFS space as oil prices rise. To that end, I recently introduced Total Energy Services Inc. (OTCPK:TOTZF), a Canadian full-service small-cap oilfield provider.
Below let’s look at another Canadian OFS game – Trican Well Service Ltd. (OTCPK:TOLWF), which trades on both TSX and OTC-Pink with adequate liquidity.
Trican Well Service
Trican was founded in 1979 and has been a public company since December 1996. It acquired i-TEC Well Solutions in 2013. Since the 2014 oil crash, Trican has sold its Russian operations to Rosneft for C$197 million (2015) , suspended operations in Australia, Algeria, Saudi Arabia and Colombia (2015), and divested its fracking business in the United States to the Keane Group for US$247 million (2016). In June 2017, the company acquired fellow fracker Canyon Technical Services for C$637 million.
Trican primarily performs hydraulic fracturing for oil and gas companies in Canada (Fig. 2).
Like Total Energy Services, Trican’s share price crashed in late 2014 and only started to recover in 2Q2020. Since the long-term low reached on March 24, 2020, the stock had delivered a 10-bagger. However, from November 2021, Trican made a minor correction, which lasted until the end of December (Fig. 3).
Business begins to improve
For a fracking specialist like Trican, one can use the total tonnage of proppant pumped as a measure of activity levels. Proppant is the solid material – usually sand, cured sand, or artificial ceramic materials – designed to hold a hydraulic-induced fracture open so that oil can flow more freely after the fracturing treatment. Given the seasonality, fracking activity has increased significantly since the 2Q2020 low, when panicked oil and gas producers literally stopped drilling wells (Fig. 4).
The increase in activity appears to be just beginning, judging by active manned hydraulic power and active maintenance/unmanned hydraulic power as a percentage of hydraulic pumping capacity of the Trican fracturing fleet (Fig 5).
However, Trican still had some 237,000 hydraulic horsepower, or 41% of its fleet capacity, which are currently parked, ie idle (Fig. 5). And the company has not yet obtained favorable prices for its services (Fig. 6). This is why quarterly revenues have yet to return to pre-Covid levels (Fig. 7).
Trican managed to maintain the adjusted EBITDA margin at ~16.8% over the previous four quarters (Fig. 8). Through disciplined capital spending, the company has generated abundant free cash flow (Fig. 9); Capital spending focused primarily on sustaining and infrastructure projects, as well as projects that brought immediate efficiencies and cost reductions.
Outlook and risk
As we approach 2022, I think Canada’s oilfield service space will likely continue to improve, judging by the increased capital budget announced by many producers.
However, oilfield service providers are facing inflationary pressures on fuel, proppants, parts and especially wages as the industry seeks to ramp up business. If Trican fails to pass on the inflating costs to its customers, which is possible with overstocked hydraulic fracturing equipment, margins could continue to suffer. On the other hand, if the company manages to negotiate advantageous prices for its services, which seems possible to me, the profitability will improve appreciably.
In addition, ESG pressure translates into an increase in capex. In response to customer demand, Trican has delivered a hydraulic fracturing fleet powered by a 48,000 HHP Tier 4 dynamic gas mixture (or DGB) engine, with the second low-emissions fleet planned for spring 2022, bringing the company’s total Tier 4 fleet at 84,000 HHP. Tier 4 engines replace up to 85% of diesel consumption with cleaner-burning natural gas. It costs $28 million to convert Tier 2 diesel fleets to Tier 4 DGB engines.
Despite the above uncertainties, Trican has a strong balance sheet to build on, with zero debt and C$38 million in cash. It has an undrawn revolving credit facility of C$125.0 million and an uncommitted accordion facility of C$125.0 million, in full compliance with the leverage ratio covenants and interest coverage (leverage ratio 2.5X). The company sold surplus or obsolete capital equipment. Since 2017, it has sold approximately C$80 million of permanently idle assets to free up stranded capital; he sold a software business in 1Q2021 for cash proceeds of $6.5 million.
Trican’s management is not only prudent in balance sheet management, but also shareholder friendly. In the first nine months of 2021, it bought back 8.1 million shares on the open market.
Trican is a leading provider of hydraulic fracturing services in Canada. With a healthy balance sheet and ample capital liquidity, it should benefit from an increase in hydraulic fracturing activity in the country.
Trican is currently valued at an EV/EBITDA multiple of 7.33X on a TTM basis, which is cheap compared to its oil services counterparts.
If you believe in an impending upstream boom in Canada, Trican is a great stock to own.