Description

Adams Resources and Energy (“AE”) is a crude oil marketing, transportation, terminalling and storage company that operates in various crude oil and natural gas basins in the lower 48 states of the United States (“U.S.”). It also conducts tank truck transportation of liquid chemicals, pressurized gases, asphalt and dry bulk primarily in the lower 48 states of the U.S. with deliveries into Canada and Mexico, and with fifteen terminals across the U.S.  AE trades at 2 times 2022 EBITDA due to the following reasons:

1.       Quarterly accounting valuation of its permanent oil inventory that generates noise in its reported results, but that has no effect on the real cash flow generated by the business. 

2.       Limited float in its stock due to heavy insider ownership.

3.       A recently acquired a pipeline business (late 2020) bought for pennies on the dollar that is still generating negative cash flows, which it expects to turnaround over the next few years.

4.       Lack of interest by investors in anything that seems Oil and Gas related

I believe that this business is positioned to grow cash flow meaningfully over the next couple of years as the US recovers from the pandemic.  AE’s assets are well positioned to benefit from acquisitions made prior to Covid that should provide significant earnings leverage which is not reflected in its stock price.  I also believe that AE is a prime target to be acquired by a larger company that can benefit from its assets.  I think that AE will be worth $71 per share by 2023 for a return of 104% over its current price of $35.00.

History

AE was founded by Bud Adams, the former owner of the Houston Oilers football team.  The Company owned interests in oil and gas fields and marketed oil for other suppliers.  The Oil and Gas assets were divested several years ago.  The Adams family still controls about 41% of the common stock and has one representative on the board of directors.  There are no members of the family in senior management of AE.  The current CEO and CFO were brought on in January 2020 and June 2018, respectively, to run the Company in a more professional manner.

Today AE operates in three business segments: (i) crude oil marketing, transportation, and storage; (ii) tank truck transportation of liquid chemicals, pressurized gases, asphalt and dry bulk; and (iii) beginning in the fourth quarter of 2020, pipeline transportation, terminalling and storage of crude oil, which includes the pipeline and related terminal facility assets it acquired in October 2020.

Crude oil marketing, transportation, and storage (Gulfmark)

Many smaller oil and gas producers are not connected to pipelines and utilize transportation companies to get their hydrocarbons to market.  These transportation companies, like Gulfmark, have long term relationships with these producers and work off a margin that covers the cost of transporting the hydrocarbons plus a profit over local hub pricing.  AE picks up the oil and aggregates it in their own terminals or directly injects it into pipelines. 

The operators choose transport companies based on reliability of service more than price since a missed pickup can cause an operator to shut down production once their storage tanks are full.  AE and other transport companies work off contracts that typically have two-year terms with evergreen month to month renewals.  The operators that I have spoken with confirmed that they are willing to pay a premium for reliability of pickup and only switch providers if it is absolutely necessary.

AE purchases crude oil at the well-head and then its drivers use owned or leased trucks to pick up and transfer the oil to the terminals it owns and then sells the accumulated oil to purchasers.  AE hedges its purchases so that there is no risk to short term price swings in oil.  AE owns a fleet of 201 tractor-trailer rigs with a weighted average age of 3.39 years.  This young fleet reduces costs through fuel efficiency and lowered repairs and maintenance.  In October 2018 it acquired Red River Trucking which expanded its fleet by 113 tractors and 126 trailers.   

This chart from the 2021 10-k highlights this information.

1. Includes forty 2021 tractors, thirty 2019 tractors and fifteen 2018 tractors that AE lease from a third party under finance lease agreements.

AE makes a spread on every barrel of oil purchased as its suppliers do not have access to pipelines to transport their production.  The chart below from AE’s 2nd quarter 2021 investor presentation (quarter ended June 20, 2021) details the number of barrels per day marketed by the Company.

As can be seen from this chart, AE has been running about 10,000 to 20,000 barrels per day below pre-covid levels.  I believe that as the US economy recovers and oil prices stay well above the $40 per barrel level, AE is positioned to increase cash flow markedly.  This is simply because higher hydrocarbon prices encourage greater production.  The Chart below details average barrels per day from 2019 to 2021.

Transportation (Service Transport Company, “STV”)

STV transports liquid chemicals, pressurized gases, asphalt and dry bulk on a “for hire” basis throughout the continental U.S., and into Canada and Mexico.  STV had grown through acquisitions prior to the pandemic with deals completed in May 2019 for EH Transport and in May 2020 for CTL Transportation.  STV operates over 375 tractors and over 800 tank trailers with 18 terminals across the US.  The map below shows the states currently covered by this operation. 

The current management team was brought on in 2017 to turnaround this operation and has built adjusted cash flow meaningfully despite the pandemic.  This is shown by the chart below.

STV services a blue-chip customer base of major chemical companies as shown below.

Revenues for this division are generated by miles driven, which has climbed due to the acquisitions over the last few years.  As covid recedes, this metric should reach higher levels than were previously achieved.  The shortage of qualified drivers in the US limits competition and should allow margins to stay stable or rise.  The chart below details miles driven.

This division also has a young fleet of tractors with an average age of 3.41 years.  This is important for both fuel efficiency and repairs and maintenance.

Competitively, Service Transport is the 28th largest operator of tank trucks in the US according to Transport Topic News as of 2019.  (https://www.ttnews.com/top100/tank/2019 ) There is still an opportunity for consolidation in this industry and AE has the balance sheet to add additional companies into its fold to increase coverage areas.  I have not taken into account any acquisitions for my model.

Pipeline and Storage (VEX Pipeline System, “VEX”)

AE’s pipeline and storage segment consists of the operations of two wholly-owned subsidiaries of GulfMark, which constitute the VEX Pipeline System: (i) VEX, which was acquired on October 22, 2020 and which owns the VEX pipeline, and (ii) GMT, which was formed in October 2020 to hold the related terminal facility assets AE acquired with the VEX Pipeline System. The VEX Pipeline System complements AE’s existing storage terminal and dock at the Port of Victoria, where with its crude oil marketing segment, AE now controls approximately 450,000 barrels of storage with three docks.

The VEX Pipeline System, with truck and storage terminals at both Cuero and the Port of Victoria, Texas, is a crude oil and condensate pipeline system, which connects the heart of the Eagle Ford Basin to the Gulf Coast waterborne market. The VEX Pipeline System includes 56 miles of 12-inch pipeline, which spans DeWitt County to Port of Victoria in Victoria County, Texas, with approximately 350,000 barrels of above ground storage at its two terminals. The pipeline system has a current capacity of 90,000 barrels per day and is regulated by the Federal Energy Regulatory Commission (“FERC”) and the Texas Railroad Commission. The VEX Pipeline System can receive crude oil by pipeline and truck, and has downstream pipeline connections to two terminals today, with potential for additional downstream connection opportunities in the future.

The Cuero terminal has 40,000 barrels per day of offload capacity via eight truck unloading stations, with two 80,000 barrels and one 16,000 barrels of storage tanks. The Port of Victoria terminal has 40,000 barrels per day of offload capacity via eight truck unloading stations and water access via two barge docks, which have been leased from the Port Authority in Victoria. The Port of Victoria has four 40,000 barrels and one 10,000 barrels storage tanks.

The VEX Pipeline System supports GulfMark’s Gulf Coast region crude oil supply and marketing business and integrates into GulfMark’s value chain, serving as the link between producers/operators and our end-user markets we supply directly along the Gulf Coast waterborne market. With GulfMark’s ownership of the VEX Pipeline System, AE can increase its efficiency by more effectively managing the pipeline and terminalling portion of AE’s overall transportation costs.

In addition to the VEX Pipeline System serving GulfMark, AE currently has opportunities to work with third parties both upstream and downstream of the VEX Pipeline System. This should allow AE to create revenues and free cash flow from an asset that was purchased for pennies on the dollar.  VEX’s previous owner was unable to leverage this asset as it could not find customers to utilize the pipeline.  I believe that AE is better suited to maximize the value of this pipeline due to its ability to leverage its relationships with local producers.

Valuation

One quirk of AE’s accounting is that during most quarters it records a small gain or loss from the valuation of inventory it has acquired but not yet sold. As part of its ongoing operations, the company always has 250,000 - 350,000 barrels of oil that is in route from producer to customer.  I think of this as a fixed asset, as it is needed to keep storage tanks at operational levels. This gain/loss hits the Marketing revenue line. In most periods, it has very little impact and tends to even out over several quarters. In Q1 of 2020, however, oil prices fell precipitously, and the company recorded at $24mm loss from this impact which resulted in an overall loss of $12.5mm on the gross profit line from the Marketing division. This hit, coupled with lower marketing volumes during covid, caused the stock to decline sharply and remain at depressed levels for the past two years. I believe that the company is at an inflection point which should cause it to see significantly higher revenues, profits and share price.

I believe that the current crisis in Ukraine will have an important impact on the Company.  I believe that this will cause a significant increase in US oil production that the Biden administration will not be able to curtail. This was already happening to some extent as post-covid demand was leading to higher oil prices making new drilling more economically attractive. At Q4 2021, marketing barrels were still 16% below their Q1 2020 levels. I assume that during 2022 this number begins to recover. However due to the tight labor market and a shortage of drilling rigs, I only expect that the average daily barrels in Q1 of 2023 are still 12% below the 2021 level and the by year end 2023 they will be 9% below the pre-covid level. I may be overly conservative in this estimate but prefer to err on the side of caution in these turbulent times.  

I expect the Transportation segment to continue its modest but steady organic growth while maintaining the much-improved margins it has achieved over the past quarters. The margin improvement is largely due to the new management team’s focus on getting re-loads for their trucks so that they are carrying loads in both directions and not just one way.  The current shortage of truck drivers should allow AE to have considerable pricing power in this segment and minimal external new competition. I expect gross margin contribution from this segment to grow from $19mm in 2021 to $22mm in FY 2023.

Finally, the Pipeline and Storage business has been a drag on profitability since it was acquired in Q4 of 2020. I believe that management has taken steps to turn this business around and that it will slowly become a modest contributor to profitability. Management is adding new connections to the pipeline which will allow other operators to gain access to it. This project should be finished by mid-summer, and I expect to see improved revenue and margins beginning in Q3, 2022. I expect a gross margin contribution of $0.3MM in 2022 and $2.2MM in 2023. Ultimately, I believe the pipeline (which cost over $250mm to build and which was acquired by AE for $20mm) will contribute $4-6MM annually once all the connections have been made and new customers are signed up.

Overall, I expect EBITDA, excluding any one-time gains from the recent spike in oil prices, to increase from $26.1mm in 2021 to $39.1mm in 2023. As discussed above this only presupposes a very modest growth towards pre-covid marketing numbers, slow growth in the transport segment, and moving the pipeline business from money losing to slightly profitable. My model is shown here:

I believe that given the company’s strong cash flow generation and the recurring nature of much of its business, a 5x EBITDA multiple is a conservative valuation metric. At 5x 2023 EBITDA, the company should have a value of $71.33/share.

Risks

1.       Oil prices decrease and therefore production decreases in the US.

2.       Driver shortages increase costs that cannot be passed on to customers.

3.       Severe weather causes damage to the Company and/or its customers.

Catalyst

Catalysts

1.       Increased cash flow and reasonable multiple expansion drive share price higher.

2.       Merger or acquisition of AE.

3.       Oil prices remaining above $60 per barrel, which is a level that affords producers profitable operations.