CES Energy Solutions Corp T.CEU

Scotia Upgrade to $4.60 from $4.35

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• CEU-T: C$2.77
• Target: C$4.60
  Old: C$4.35
• Rating: Sector Outperform

What a Difference a Few Years Make

OUR TAKE: Positive. Let’s compare mid-cycles: in 2019, CES generated sales, EBITDA, and FCF before working capital of $1.3 billion, $167 million, and $68 million. Compare that to 2022 levels of $1.9 billion, $257 million, and $137 million – increases of 50%, 55%, and 100%, respectively. The growth has been driven by share gains (rigs and production are still below pre-COVID levels in the U.S.), secular trends towards increased drilling intensity, price increases, and leveraging excess capacity (built out in 2017-2019). Read: we think the growth is structural.

Despite that, the valuation remains depressed with shares trading at 4.2 EV/EBITDA on our 2023E compared to a historical average of 6.5x, which we attribute to macro concerns and muted FCF generation (and capital returns) during a period of significant growth. But the market can’t have it both ways: as cash flows run counter to the cycle for CES, we expect stabilizing activity levels to lower working capital requirements and drive outsized FCF generation in 2023 (and eventual return of capital). We view the company’s net w/c balance as its “piggy bank” that it can tap as the cycle matures. We forecast a w/c surplus of $750 million by the end of this year.

KEY POINTS

CES reported 4Q22 sales and adjusted EBITDA of $563 million and $80.2 million compared with consensus of $537 million and $75.8 million (see First Take). Compared with consensus, the beat was driven primarily by higher sales (80% of the beat). The company is “optimistic” about growing the top-line and EBITDA this year underpinned by 1) a flat to modestly up rig count environment in the U.S. and Canada and 2) adjusted EBITDA margins in the 13% to 15% range. The company also expects “significant FCF” in 2023, inclusive of capex of $55 million (vs $50M last year).

FCF before working capital was $48M; or $20M inclusive of w/c. Working capital investment as % annualized quarterly revenue was 30.9% – down q/q for the second quarter in a row – and at the low end of the company’s targeted range of 30% to 35%. On the call, management noted that following a period of significant top- and bottom-line growth, it is now focused driving w/c efficiencies. We forecast FCF after working capital of ~$120 million in 2023.

The company continues to take a balanced approach to capital allocation. Beyond investing in the business, we believe the company will prioritize deleveraging towards its target range of 1.5x to 2.0x (compared with 4Q exit rates of 2.2x), likely a 1H23 event, before exploring other return of capital scenarios.

• Quarterly Financials
• Yearly Financials

Historical price multiple calculations use FYE prices. All values in C$ unless otherwise indicated.
Source: FactSet; company reports; Scotiabank GBM estimates.

Qtly Adj EBITDA (M)	Q1	Q2	Q3	Q4	Year	Current EV/Adj EBITDA
2020A	$51	$8.2	$18	$25	$102	12.5x
2021A	$34	$32	$42	$48	$156	8.2x
2022A	$42	$61	$73	$80	$257	5.0x
2023E	$76	$69	$79	$81	$305	4.2x

Exhibit 1 - North American Peer Group

Source: Company reports; FactSet; Scotiabank GBM estimates for CES Energy Solutions Corp.

Exhibit 2 - Financial Forecasts ($ Millions, Unless Otherwise Noted)

Source: Company reports; Scotiabank GBM estimates.