Basic Energy Services Inc.

Basic Energy Services Inc. (“BAS” or “Basic”) is an US oil field services provider trading at a substantial discount to historical valuations based on mid-cycle cash flows for this industry group.  Oil service stocks like Haliburton (HAL), Schlumberger (SLB) and Weatherford (WFT) typically trade at around 10 times mid-cycle enterprise value to trailing twelve months EBITDA (EV/EBITDA). Assuming a 20% discount for BAS’ smaller size, if Basic traded at 8 times its mid-cycle conservatively estimated EBITDA of $200 million it would be worth $1.6 billion in enterprise value.  Subtracting out current net debt of $250 million leaves $1.35 billion of equity value to be divided by 26.4 million shares yielding a share price of $51 per share.

Background

Basic Energy Services Inc is an US oil service company that competes in the areas of well completion and remediation, well servicing and water logistics.  BAS built each of these businesses via internal growth and a series of acquisitions from 2006 to 2012. In 2016, BAS filed a prepackaged bankruptcy with its bondholders effectively acquiring the Company for forgiveness of the great majority of outstanding debt.  Today BAS is a lightly leveraged company with a shareholder base still largely composed of former distressed debt and equity value investors.

BAS, like all oil field service companies, goes through boom and bust cycles based on the price of crude oil in the US.  The collapse in crude oil prices in 2015 caused a shake-out in the US oil service sector with many companies “mothballing” equipment and firing teams of employees.  Today, with oil prices comfortably in the $60 to $70 per barrel price range, oil service companies are raising prices to cover increasing labor costs and improve profitability.

BAS stock is trading at distressed levels despite the beginnings of this recovery due to competitive issues in the Permian Basin for fracking services and has begun to realign assets to maximize profitability.  Analysts expect BAS to generate $117 million in EBITDA this year and $147 million in 2019. It is not a stretch to imagine that there is upside to these projections if the price of oil stays in the current price range.

Each of these verticals has different economics based on the competitive aspects of the regions covered by BAS.

Well completion and remediation

This segment is composed of Pumping, Coiled Tubing and Rental Tools used to support the fracking and maintenance of existing and new wells.  BAS has operations across the US and the following table highlights the location of these assets as of December 31, 2017.

The Company is currently shifting some of its Pumping Units from the Permian Basin to other markets due to an oversupply of horsepower in that market.  This will cause a small loss in revenues in Q3 2018 as that equipment will be non-revenue generating during the transition. As per management’s statement, this will increase margins and revenues going forward due to higher demand in the transfer markets from existing customers.

Well Services

BAS Well Services encompasses a full range of services performed with a mobile well servicing rig, also commonly referred to as a workover rig, and ancillary equipment.  As per the 10-K BAS states that:

Our rigs and personnel provide the means for hoisting equipment and tools into and out of the well bore, and our well servicing equipment and capabilities also facilitate most other services performed on a well. Our well servicing segment services, which are performed to maintain and improve production throughout the productive life of an oil and natural gas well, include:

•                          plugging and abandonment services when a well has reached the end of its productive life.  Here is a breakdown of BAS equipment in this arena as of December 31, 2017:

Rig hours, utilization and operating margins are continuing to climb due to the recovery in oil prices.  BAS will consider bringing back “mothballed” units as pricing and demand continue to rise. Here is a chart from the last quarterly call highlighting this trend.

Water Logistics

This segment provides oilfield fluid supply, transportation, storage and construction services. These services are required in most workover, completion and remedial projects and are routinely used in daily producing well operations. These services include:

BAS is benefitting from the shift to using pipelines from trucks to transport water to and from wells.  Pipelines carry higher margins than trucking due to less labor and capital needs once the pipeline is operational.  As per the second quarter 2018 earnings call margins are healthily in the mid 20% range (Q2 2018 margins were impacted by weather) and management has guided that price increases are sticking with customers.  Here are the figures from the call.

Here is a list of the assets in this sector as of December 31, 2017:

Thoughts

It appears that the US oil service industry has hit an inflection point where demand is outstripping supply and providers have the ability to raise price in excess of cost increases.  While BAS had a choppy Q2 2018, it is now;

1.       utilizing 82% of its well servicing fleet and is providing full day packages for its equipment on an increasing basis.

2.       transporting 23% of water volumes through pipelines

3.       raising prices mid-single digit for Well Servicing and low single digit for Water Logistics

4.       relocating fracking assets from the Permian Basin to the Mid-Con and signaling that monthly run rate revenues exiting September should be 10% - 20% above the third quarter average

Management seems to be positively influenced by these trends as they just purchased more $170,000 in BAS stock after last week’s correction.

Risks

The risks to BAS achieving increased EBITDA and revenues are the following;

1.       a decrease in oil prices below production costs in the US.

2.       a change in US or state regulatory rules that makes it illegal or not cost effective to frack oil wells.

3.       a rapid increase in the supply of newly manufactured fracking equipment.

The main risk with investing in oil service companies is always the price of oil.  Competition has lessened over the years as smaller companies have been weeded out of the sector.  Private equity has come into the Permian and that has depressed margins in this recovery. If this were to spread to other areas, then there could be risk to EBITDA growth for the industry.  I view this as highly unlikely, but it is a risk. I view bullets 2 and 3 as unlikely over the time-frame of this investment.