CES Energy Solutions Corp T.CEU

From Scotia this morning

[savyinvestor333]

Oilfield Services

CES Energy Solutions Corp.

• CEU-T: C$2.72
• Target: C$4.35
• Rating: Sector Outperform

Keeping it PC

OUR TAKE: Positive. We don’t think CES gets enough credit for its more resilient production chemicals (PC) business. In the past, the company has disclosed that PC makes up 50% of sales. However, we think that percentage has trended upwards over the past two years as U.S. oil production has recovered to 2019 levels, while rig counts remain about 20% below. We also think the company has made share gains in PC similar to its DF business. The closest pure-play comp is ChampionX (CHX-US; not rated), which trades at 8.2x EV/EBITDA on consensus 2023E estimates compared to CEU at 4.4x on our 2023E.

We expect an inflection point in FCF in 1H23. We forecast $150 million in 2023 (>20% yield), which could accelerate deleveraging and lead to a positive re-rate. Alternatively, BVPS was $2.23 as at 3Q22 and we forecast EPS of $0.50 in 2023 – which means that at the current share price, investors are effectively only paying for book value and one-year’s worth of earnings. The valuation is at odds with what we view as structurally enhanced earnings power and return metrics achieved over the past two years.

KEY POINTS

Is production chemicals a better business than drilling fluids? We think so. By better we mean primarily lower earnings volatility. PC demand is driven by oil production, which is relatively stable compared to rig activity (see Exhibit 1 and 2). For context, in 2020, CES’s sales and adjusted EBITDA declined 30% and 40% y/y, respectively, compared to a 55% decline in active rig counts and a 7% decline in production.

How much is production chemicals worth? More than is priced-in. ChampionX is the closet pure-play comp given 60% of its sales are production chemicals. It is the #1 U.S. land production chemicals player (CES is #2; #1 in the Permian). CHX trades at 8.2x EV/EBITDA on consensus 2023 estimates. We think CHX warrants a premium to CEU given its its higher EBITDA margin profile (due to its exposure to the offshore market and scale) and greater trading liquidity. Valuing CES’s PC business at a 1.0x discount to CHX, and an in-line multiple for DF, implies a valuation of 6.0x EV/EBITDA for the entire company or $4.60/share (+70% from current levels). (See page 2 for sensitivities).

Value with a catalyst. The main drag on FCF over the past two years has been working capital investment following the steep recovery in oil market activity. As rig counts and production have flattened out in 2H22, we expect w/c investment to follow suit into 2023. CEU trades at 4.4x EV/EBITDA on our 2023E, which breaks out to 2.5x of equity and 1.9x of debt. We forecast FCF of $150 million in 2023, which would effectively transfer 0.5x of value to equity from debt holders – before a potential re-rate closer to historicals (c. 6.5x NTM EV/EBITDA).