CES Energy Solutions Corp T.CEU

Scotia upgrade to $4.35 from $3.90 Outperform Rating

[savyinvestor333]

Executing to Plan

OUR TAKE: Positive. When we launched coverage, margins had hit a low point as CES (and the entire OFS complex) faced unprecedented cost inflation. Our thesis was three-fold: (1) additional price increases would gain traction in the 2H and margins would return to historical levels; (2) as activity levels stabilized, working capital build would slow; and (3) this would open up several potential return-of-capital scenarios. The 3Q margin print of 14.0% was flat q/q – and back to 2017-2019 levels – demonstrating the company’s ability to recover and maintain margins in an inflationary environment. As rig counts and production have remained effectively flat q/q, we expect FCF generation to accelerate in 4Q and into 2023. The dividend increase of 25% (to $0.08/share annualized) is a harbinger of part three of our thesis.

We made upward revisions to our estimates and raised our target price by $0.45/share to $4.35/share. We value CEU at 5.75x EV/EBITDA on our 2023E, which is below an already derated historical average of 6.5x. Despite the recent move up in the shares, we continue to see significant value: we forecast CEU will generate FCF of $170 through 2023, which is equivalent to >20% of its market cap.

KEY POINTS

Adjusted EBITDAC came in 7% ahead of consensus on higher sales. Both sales of $525 million and adjusted EBITDAC of $73.3 million set another consecutive quarterly record. Sales growth of 21% q/q outperformed industry activity levels. The company also continued to get price increases and maintain share gains achieved in 2020 (including a basin-leading 29.8% share in the Permian). Adjusted EBITDAC margins of 14.0% were flat q/q despite unfavourable mix and FX. We believe current supply/demand dynamics are supportive of current margin rates.

FCF before working capital was $38 million. Working capital investment was $65 million. Working capital investment as % annualized quarterly revenue was 32% – in line with our expectations and within the company’s targeted range of 30% to 35%. We forecast working capital build to decelerate materially in 4Q and into 2023 as sales growth moderates.

The dividend was increased by 25% to $0.08/share annualized (2.6% yield). For context, this was the first increase since 2018 and the highest quarterly rate since 1Q16. Net debt was $562 million (+$38 million q/q). Net debt to EBITDA was 2.5x (-0.2x q/q). Notably, the net draw on the senior facility is currently $218 million versus $221 million on September 30 despite a $15 million outflow since quarter-end for coupon payments ($9 million), dividends ($4 million), and share repurchases ($2 million). As FCF accelerates in 4Q and 2023, we believe CEU will prioritize debt repayment. For additional detail on 3Q22 results, see our “First Take”.