CES Energy Solutions Corp T.CEU

Scotia Upgrade to $3.90 Sector Outperform

[savyinvestor333]

CES Energy Solutions Corp.

• CEU-T: C$2.82
• Target: C$3.90
  Old: C$3.60
• Rating: Sector Outperform

Cruising to a New Altitude

OUR TAKE: Positive. Between 2017 and 2019, CES invested ~$155 million to increase capacity. Lower WTI prices (in 2H19) and COVID reduced industry activity levels and delayed the ramp in sales. But, the 2Q22 results clearly demonstrate that the company is starting to reap the rewards of those investments. Revenues are run-rating at $1.7 billion compared to the previous mid-cycle of $1.2 billion. At the same time, margins have recovered to historical levels following successful pass-throughs. Altogether, 2Q adjusted EBITDA of $61 million, achieved in a seasonally weak quarter, set a new high watermark versus $55 million in 3Q14.

We believe the true litmus test of the investments is the expanded return metrics and book value build: LTM ROE of 14.1% compares to an average of 6.0% between 2017 and 2019; and as at 2Q, tangible book value per share was $1.65 compared to $0.85 at the end of 2017, which equates to a >15% CAGR over the period. We continue to value CES at 5.75x EV/EBITDA on our 2023E (raised by 15%), which is below an already derated historical average of 6.5x. We are raising our target price by $0.30/share to $3.90/share.

KEY POINTS

Firing on all cylinders. 2Q sales increased 8% q/q and set a third consecutive quarterly record (as well as record revenues in each of CES’s four divisions). Higher sales were driven by strong activity levels and price realization (and mix in the U.S.). QTD rig counts are up 9% q/q in the U.S. and 28% y/y in Canada. Production levels are up 7% QTD in the U.S. We believe CES’s PC business can grow above these rates given the trend towards fewer wells and higher completions intensity (fluid intensity per foot is up 13% y/y in 2022).

One company’s inflation is another’s pricing power. Adjusted EBITDAC margins of 14.1% recovered to historical levels on pricing increases and operating leverage. Over the past few months, commodity producers have been contending with cost inflation while OFS peers have been securing price pass-throughs. We believe the operating environment is supportive of more increases due to: 1) tightness in certain products; 2) concerns around security of supply; 3) a willingness to pay a premium for service; and 4) a rational competitive environment.

FCF will come. We expect FCF to turn positive in 2023 – we forecast $0.46/share (16% yield). The company increased 2022 capex guidance to $50 million (from $40 million) commensurate with the increase in sales. We previously estimated it could increase sales by $500 million (from a base of $1.2 billion) without requiring much capital. W/C surplus is expected to remain within the range of 30-35% of annualized revenue. The company announced an amendment to its indenture agreement increasing its max credit facility.

• 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	11.9x
2021A	$34	$32	$42	$48	$156	7.8x
2022E	$42A	$61	$62	$63	$229	5.3x
2023E	$68	$65	$69	$69	$271	4.5x

Exhibit 1 - North American Peer Group

FCF yield for CES before working capital.

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

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