CES Energy Solutions: It's The Mud

seekingalpha07-26

CES Energy Solutions Corp. has rallied on strong performance in Q4 of 2023 and Q1 of this year, with analyst coverage increasing and price targets ranging from $7.00 to $10.50.The company dominates ...

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Did somebody say Mud?","collect":0,"end_time":0,"defaultTopTitle":"seekingalpha.com","property":[],"viewcount":null,"language":"en","relate_stocks":{"LU0211331839.USD":"FRANKLIN MUTUAL GLB DISCOVERY \"A\" (USD) ACC","LU0433182093.SGD":"First Eagle Amundi International AS-C SGD","LU1878469433.USD":"THREADNEEDLE (LUX) - AMERICAN SMALLER COMPANIES \"A\" (USD) ACC","LU1720051108.HKD":"ALLIANZ GLOBAL ARTIFICIAL INTELLIGENCE \"AT\" (HKD) ACC","LU0068578508.USD":"First Eagle Amundi International Cl AU-C USD","BK4109":"特种化学制品","IE00B19Z3581.USD":"Legg Mason ClearBridge - Value A Acc USD","LU0208291251.USD":"FRANKLIN MUTUAL U.S. VALUE \"A\" (USD) INC","BK4585":"ETF&股票定投概念","IE00B19Z3B42.SGD":"Legg Mason ClearBridge - Value A Acc SGD","LU0256331488.USD":"SCHRODER ISF GLOBAL ENERGY \"A\" ACC","FTK":"Flotek工业","SLB":"斯伦贝谢","NR":"新园能源","CESDF":"CES Energy Solutions Corp.","SG9999004303.SGD":"Nikko AM Shenton Global Opportunities SGD","LU2237438978.USD":"Amundi Funds US Pioneer A2 (C) USD","BK4588":"碎股","LU0320765489.SGD":"FTIF - Franklin Mutual US Value A Acc SGD","LU1489326972.SGD":"First Eagle Amundi International AHS-MD SGD-H","IE00B0JY6N72.USD":"PINEBRIDGE GLOBAL EMERGING MARKETS FOCUS EQUITY \"A\" (USD) ACC","HAL":"哈里伯顿","LU0070302665.USD":"FRANKLIN MUTUAL U.S. VALUE \"A\" (USD) ACC","LU2236285917.USD":"ALLIANZ GLOBAL INCOME \"AMG\" (USD) INC","LU0368265418.SGD":"Blackrock World Energy Fund A2 SGD-H","BK4179":"石油天然气设备与服务","LU1720051017.SGD":"Allianz Global Artificial Intelligence AT Acc H2-SGD","IE0002270589.USD":"LEGG MASON CLEARBRIDGE VALUE \"A\" (USD) INC","LU2357305700.SGD":"Allianz Global Artificial Intelligence ET H2-SGD","LU1548497426.USD":"安联环球人工智能AT Acc","SGXZ23171101.USD":"NIKKO AM SHENTON GLOBAL OPPORTUNITIES (USD) ACC","LU0300736492.USD":"FRANKLIN NATURAL RESOURCES \"A\" (USD) INC","LU0985489474.SGD":"First Eagle Amundi International AHS-C SGD-H","LU0300736062.USD":"FRANKLIN NATURAL RESOURCES \"A\" (USD) ACC","CHX":"Championx Corporation","LU0122376428.USD":"贝莱德世界能源基金A2","LU0878866978.SGD":"First Eagle Amundi International AHS-QD SGD-H","LU0077335932.USD":"FIDELITY AMERICAN GROWTH \"A\" INC"},"translate_title":"CES能源解决方案：这是泥浆","themeId":null,"isJumpTheme":false,"ttsUrl":null,"symbols_score_info":{"SLB":1,"CESDF":1,"CHX":1,"FTK":1,"HAL":1,"NR":1},"content_text":"CES Energy Solutions Corp. has rallied on strong performance in Q4 of 2023 and Q1 of this year, with analyst coverage increasing and price targets ranging from $7.00 to $10.50.The company dominates the U.S. drilling fluids market, especially in the Permian Basin, and offers a combination of big company fluids technology with small company service.CES provides drilling fluids that enable longer lateral sections and reduce time to total depth, with a focus on high tech chemistry to lower unit costs and enhance well productivity.We think the current 8X multiple suggests patience in establishing new positions at current levels.  Did somebody say Mud? Justin Paget/DigitalVision via Getty Images Introduction Last fall, we recommended CES Energy Solutions Corp. (OTCPK:CESDF) in a Daily Drilling Report internal article, at $2.19 per share! The company has rallied strongly on superior performance in Q4 of 2023, and Q1 of this year. AES (the U.S. division of CES) has a big chunk of the U.S. drilling fluids market, and is especially strong in the Permian with 33% of the market. AES offers big company fluids technology with small company service. A very appealing combination, that market is clearly rewarding. CES Price Chart (Seeking Alpha) Since we last covered them, the analyst coverage has increased a good bit as well. The eight analysts covering the stock rank it as a buy, with price targets ranging from $7.00 to $10.50. The median is $8.75 implying most of them remain bullish on the company. The company has a year-long pattern of beating estimates, which, among other things like an aggressive capital return program, accounts for the performance of the stock. Estimates for Q-2 are modest at $0.16 per share, a number they beat easily last quarter. Another beat could move the stock toward the analysts' midpoint range or higher. We think the analysts may be a little ahead of the market at current levels, and are calling a hold at current prices. We just the stock fully reflects market conditions at the present. Investors with large positions might also want to consider taking some profits at current levels. The thesis for CES CES is a top-tier provider of drilling fluids that are used to drill oil and gas wells. Drilling fluids-mud, are the often unsung heroes of the well construction process. Well-designed fluids facilitate well economics by enabling longer lateral sections and reducing time to total depth. When things go wrong on a well, however, they typically, very appropriately get the blame. There's a saying in the oilfield, “It's always the mud.” CES Footprint (CES) The graphic above shows the breadth and depth of CES' integrated service offering across North America. The high-level thesis for the company involves the longer lateral sections that feature prominently in shale operators plans. As we will discuss, these are more risky to drill and require more sophisticated solutions than before. CES is also a provider of high tech chemistry that lowers unit costs and enhances well productivity. The need for these fluids has a long tail, as shale wells have a short cycle time and must be continuously replaced to maintain output. Q1 and Guidance Judging from the Q-1 conference all commentary, CESDF did a terrific job of swimming against the tide. In a market that saw declining activity here in the U.S. they posted record revenue, EBITDA, free cash and improved EBITDA margin. Corporately, they repurchased nearly 10% of their outstanding float under their NCIB, and announced plans to do the same under the new NCIB next year. The company also pays a modest dividend. In addition to dominance in the North American drilling fluids market, strong results from their PureChem-Production chemicals and stimulation business in Canada, and their JACAM Catalyst-Production chemicals and stimulation business in the U.S., contributed to this performance. We will expand the discussion on the impact of proper chemistry in extended reach drilling and on reservoir production implications. The Canadian Drilling Fluids division continues to lead the WCSB in market share. CES is providing service to 39 of the 118 jobs now underway in Canada. AES, the US Drilling Fluids group, is servicing 132 of the 605 active rigs listed and represents a continued number one market share of US land rigs at 21.8%. AES also continues to enjoy a basin leading 104 rigs out of the 316 listed are working in the Permian Basin, again, equating to their highest ever market share in this basin of 33.1%. The company noted in the call that increased footage being drilled each day, along with more complicated chemical solutions and service being provided due to the complexity and length of the horizontal sections, contributed to the strong financial performance by AES. This was despite a rig count that was almost 20% lower than its peak last year at this time. Source. A couple of catalysts for CES Commentary from operators in key basins-Permian and Eagle Ford in particular, suggests these longer lateral sections are here to stay. That sets the stage for increased revenues and profits in drilling and completion operations. The next thing is, it is clear to me there is substantial synergy with the drilling fluids business and the PureChem/JACAM Catalyst businesses. Longer wells in more complex formulations require this synergy to optimize drilling time and eventual production. We saw this with Schlumberger's (SLB) pending takeout of ChampionX (CHX). Chemistry plays an increasingly important role in completion operations as well, a brief look at Flotek's (FTK) recent rally is also instructive here, moving higher while fracking companies have tread water or lost ground. Why does chemistry matter? I am going to get a little wonky here, so if this stuff bores you…bear with me. We all know that the industry is extending the lateral length of horizontal wells to optimize costs and production. What we don't discuss often is what that means in terms of drilling fluids selection. All things being equal, the industry prefers to use water-based fluids over oil-based fluids. They are cheaper, generally have superior carrying capacity at lower circulation/pump rates, and are notionally more environmentally friendly. The downside to water-based fluids is the water fraction. Shale consists of clays that react with water and can cause enormous problems in drilling-stuck pipe, hole collapse, hole out of gauge. Remember they want to run steel casing to TD, try that with an out of gauge hole, and you are liable to be Yo-yoing the casing and burning daylight-flat time. You will never meet your AFE targets in that scenario. Hole tortuosity also plays a role in fluids compatibility with the well bore design. Well, paths rarely resemble the two-dimensional cartoons used to illustrate them. Geology and avoidance of other well paths play a role here and contribute to “tortuosity” — sometimes referred to as DLS or “Dog-Leg-Severity.” The impact here is friction. One way to think about friction is in the tensile or compressive strength of the pipe. Steel is tough stuff, but has engineering design limitations. If you exceed them, you have a fishing job-fishing the drill string is usually no big deal, but occasionally can be a nightmare, and more flat time. That's where chemistry comes in during drilling. CES and others have developed innovative water-based chemistry to reduce frictional impacts and water availability that enable these longer reach wells to be drilled. Once the well is drilled and casing landed on depth, the next stage is fracking. Fracturing is done using water as a carrier for the sand/proppant, and introduces damage mechanisms-particulate plugging, emulsions, reaction products- I could go on here for ten pages, so I'll wrap it up. CES through its PureChem and JACAM Catalyst subsidiaries has chemistries that can be deployed to address these concerns and promote maximum recoveries from a completed well. Ok, school's out. The point here is that each well is different and needs to be addressed in a bespoke manner. Not that there aren't similarities, but the skill and knowledge of the sales technicians in designing these treatments and solutions plays a big role in well efficiency and productivity, and the resultant profitability of the project to CES. CES has a bunch of Fluidsdocs. Risks The bright spots for the big, international OFS companies like Halliburton (HAL) and Schlumberger (SLB) are in the Middle East, Northern Africa-MENA, and AsiaPac countries. CES has no exposure here, so is disproportionately exposed to North America. CES seems to be looking to address this risk, and made some commentary in that regard in the last call. Internationally, if something popped up that caught our attention that fit the bill for what we’re looking for at the price we’re looking to pay, then obviously, we would take a close look at jumping on that. But we’re not looking for anything big. It’s more just to get some people and footprint on the ground somewhere, because that would definitely make – we’ve tried – we’ve spent some time in the Middle East prior working with customers without a foothold there or employees there and building it out, and it’s a tough slog, it’d be much more comfortable to just buy an existing business with an existing revenue stream. It should be noted here that Newpark Resources (NR) is considering exiting the drilling fluids business and is due to render a decision soon in that regard. I discussed this at some length in an article last March. Please give it a read for more information. Your takeaway You have to be impressed with CES' ability to ride the crest of the wave and reel in top-tier results in a stagnant to declining market here in North America. CES is trading at about 8X EV/EBITDA, and there aren't a lot of pure play standalone public drilling fluids companies with which to compare them against. NR was the only one I could think of at this late hour, and they are not a pure play OFS company any longer. EV/EBITDA comparison (Seeking Alpha) I don't know that I would put new money to work in this name at current multiples. The recent rally could begin to look parabolic given the state of commodity prices. Conversely, the best quarters lie ahead in Canada and in the U.S. drilling will start to pick up with WTI in the $80's. If we see a turn in gas drilling, the shares could get a further boost. The great results from Q-1 may repeat in Q-2, 3, and 4. The company did put a caution for Q-2 in their commentary that is also potentially instructive for us going forward. Tony Aulicino, CFO, comments- So, when we look forward going into Q2 that always is a little bit seasonally slower than Q1. And in terms of sustainability of 17.3%, I think that’s a big, big expectation. And it’s going to be difficult to gauge over the next few months, but we’ll come up for air probably in August when we were reporting Q2 and have a pretty good feel for where things are going. With the 50% run up in shares since March, I think CES rates a hold at current levels, pending Q-2 results on August, 9th, and any directional sense we get from commodities in the near term. Summing up. CES clearly has some “special sauce” that sets them apart from other OFS companies, and belongs in the portfolios of investors looking for exposure to the upstream energy space. At all-time highs, prudence suggests monitoring CES Energy Solutions Corp. for an opening at a lower price before jumping in. CES gets a hold from us at current multiples, but at a 6X or so it would hard not to take a position for continued growth, including the impact of the aggressive float reduction now underway.  Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. 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