STEP Energy Services Ltd.
1Q22 - What a difference a year (or two) can make; Upgrading to Outperform, Speculative Risk
Our view: We are upgrading shares of STEP to Outperform, Spec. Risk (SP, Spec Risk prior) with an $8.00 price target. We believe the company is increasingly positioned to benefit from a soldout US fracturing market, which should drive more consistent utilization and stronger service pricing. Increased FCF generation should also allow the company to de-lever its balance sheet and enable modest multiple expansion.
Key points:
US: Material upgrade to estimates. We expect US industry fracturing horsepower utilization to average 80-90+% in 2022/23, with many contractors effectively sold out. A growing chorus of providers have also pledged to focus on growing margins versus market share. As a result, industry prices have increased sharply, particularly in the Permian where STEP primarily operates. The current environment should support strong corporate utilization and margins, despite historical utilization swings. We estimate STEP's 1Q22 annualized EBITDA/fleet was approximately $9-10MM, which we expect to improve to $11.7MM per fleet in FY22 and $13.8MM in FY23.
Canada has generally been a solid contributor. 1Q22 EBITDA margin of 22% increased 6% y/y on 34% higher revenue from strong equipment operating days. The impact of 10-15% price increases part way through 1Q22 should also be reflected in subsequent quarters. We are modeling strong 81% utilization on STEP's active pressure pumping horsepower through 2022.
Improving FCF enables leverage reduction. We estimate STEP's 2022 net debt/EBITDA of 1.2x, declining to 0.9x in 2023. We also estimate STEP to generate $26MM of pre-dividend FCF in 2022, covering its $7MM/quarter term loan repayments. Our 2022/23 EBITDA estimates have increased to $138/159MM ($104/$127MM prior) vs the Street of $128/$149MM.
Key risks to our upgrade thesis. We keep a Spec. Risk qualifier on our Outperform rating, to reflect: 1) Outstanding balance sheet refinancing risk as the company seeks to refinance its July 2023 $200MM term loan; and 2) We forecast US utilization to remain strong, though given STEP's relatively small footprint, fleet downtime can cause impactful revisions to estimates.
Upgrade to Outperform, Spec. Risk rating and price target of $8.00 ($4.00 prior). Our price target is based on a 4.5x multiple (3.5x prior) of our increased 2023 EBITDA estimate. We have increased our target multiple toward STEP's historical trading range (5.0x) based on improved growth exposure and EBITDA/FCF margins. Our target multiple remains a discount to our frac coverage universe (LBRT, TCW, CFW) average of 6.5x. We expect STEP to trade at a discount to LBRT/TCW, primarily on smaller size, perceived stock liquidity discount, and higher balance sheet leverage