Introduction
Flotek Industries (NYSE:FTK) made some pretty abrupt changes after the first of the year. Seasoned oilfield exec, CEO John Gibson was summarily shown the door in mid-January just after a "Fireside" chat (that no longer appears on their site), to "pursue other professional interests." CEO's don't often disappear so unceremoniously. The pace of the exit fires the imagination as to the actual causes, but we have no details, so that's as far as we can go.
Flotek price chart(Seeking Alpha)
In the past, I've been increasingly critical of FTK. With good reason. They seemed directionless and were burning cash, and engaged in double-speak about how sanitizers would become a viable business for them. That outlook changed last year and we noted it in ourlast article, where the company got an upgrade from Strong Sell to Buy. We feltthe association with ProFrac Holding (ACDC) had changed the trajectory for the company. So far it hasn't helped the stock price much, but we think the tide could be turning.
When FTK reports on March 20th, we will get an idea of the true impact of this association. In recent trading the company has dropped below $1.00, below the minimum to maintain an NYSE listing. Something has to change. The most likely outcome is a reverse split in my view. As such, I would suggest waiting for their report before taking the plunge.
Please forgive the AC/DC rock band reference in the title. Anytime I mention ProFrac Holdings, ...well you can see why it comes to mind. Can't you? On to business.
The OFS landscape
I will offer some commentary now about the change in expectation for this sector-OFS, of the industry over the last few months. In late November and early December of last year oil had just fallen from the mid-$90s to the low $70s and most of the pundits-myself included expected it to at least regain the upper $80s. It actually did in the first couple of months of 2023, oscillating between the mid-$70s and the low $80s. That expectation set up a bullish tone in the Q-1 Conference Calls-Halliburton (HAL), Schlumberger (SLB), Helmerich & Payne (HP), Patterson-UTI Holdings (PTEN) and others. All reported in late January or early February, and reported rip-roaring quarters for Q-4, 2022 and high expectations for 2023.
On March 6th, that expectation was dashed as WTI sank, and sank, and sank...down into the mid-$60s, and forces a recalibration about expectations for these companies over the next quarter or two. Or three. Let's call it full year 2023.
As I have noted in past articles , when crude prices drop like they have recently, and particularly when they go through psychological thresholds, of which $70 per bbl was one, oil companies renegotiate contracts. I think the upward momentum in pricing is over, and it is very likely we could see some retrenchment. This will bring down EPS estimates and earnings multiples could be compressed. Stock prices could stagnate, or go lower from here.That's just life, and on the good side it will lead to a new expansion cycle starting. As I have discussed we need a macro catalyst to change the lower for longer view of oil, and we just aren't getting right now. Until that happens, it could be a rocky road for the OFS companies.
Against that backdrop it's important to understand that FTK is a marginal, microcap player that was thrown a lifeline by ACDC. It remains to be seen what happens with it, although first impressions are good.
The FTK update ahead of the earnings release
As previously noted some abrupt changes occurred after the first of year as regards the management structure of the company. The CEO was replaced with a board member, and a search announced for a new CEO. This was expected in my case at least. Gibson had the right credentials-seemingly, but oversaw the complete squandering of a cash bonanza that came from selling off a key part of the company-Florida Chemical in 2019 to ADM (ADM) for $175 mm. By Q-3, 2022 FTK's cash position had declined to $8.5 mm.
There's nothing like spending money to make people feel like they are doing something, and it's as true in corporate America as it is in government. And, to be fair FTK's "snakeoil" (D-Limonene- a terpene solvent actually a very useful chemical, with wide industrial applications) business had blown up - revenues had fallen from$371 mm in 2014, to $53 mm in 2021, as customers, disappointed in results, started looking for other well stimulation solutions.
FTK was searching for a new business on Gibson's arrival, andJP-3 seemed like just the ticket. They gave the owners $36 mm (cash and debt assumption), hired a few of the legacy JP-3 folks, and proceeded to burn cash while making little or no progress replacing the revenue from D-Limonene. By March, of 22 TTM revenue was still stuck on about $45 mm. Gibson's arc through Flotek is summarized byThe Houston Energy Blog.
Mr. Gibson joined the company in January 2020. Four months later, the company paid $36 million (including $25 million in cash) for an oilfield data analytics company. The purchase price included $17.5 million of goodwill and $12.9 million of intangible assets. Four months after the acquisition, the company wrote down those assets by $24.2 million. The remaining goodwill was written off in 2021.
We'll come back to JP-3, because they've been handed a pretty strong use case for that technology by the Biden administration.
Risks
Obviously they need to get the stock price over $1.00. I think a reverse split is a risk for current shareholders. Even if it rises over the $1.00 NYSE listing threshold, there are reasons to just get the stock price off rock bottom and the company may deem it desirable to do so.
If the ProFrac contract looks to be substantially less than $200 mm per year, the company could be dead money. In this dodgy environment investors are skittish and will cut and run when promises aren't kept.
Finally, there could be a nasty surprise when they release earnings. It's never good when companies break stride on these releases. There is always a reason and they've been scrambling to put the best face on. I am not really expecting this, but the fact they are reporting about a month out of their usual sequence can't be ignored.
Your takeaway
As noted FTK is interesting for only two reasons. The first obviously is a progress report on chemical sales to ProFrac. From March revenues had grown to $45 mm as of the Q-3 report. If we project the growth from Q-2-$29 mm to $45 mm, or 64% QoQ, Q-4 should come in around $75 mm. The company is more modest in their Q-4 projection as shown in the slide below, but there could be a surprise in store if the commentary from the ProFrac Q-3 report is any guide. If my estimate is closer, it would put TTM revenues in the neighborhood of $163 mm, about where they were in 2018 when the stock was $6.00 per share. More importantly it would be a big step toward ratifying management's estimate of a $200 mm annual valuation on the ProFrac business.
Flotek Revenue trend(Flotek)
The second reason, and this could be significant is the nascent JP-3 methane monitoring business. The EPA has justproposed a rulefor methane monitoring, that will make monitoring like that offered by JP-3 mandatory. Bullish commentary in that regard, particularly news of contracts or revenues would make the case for FTK quite compelling. Methane monitoring is real and it's here to stay.
Wrapping this up. FTK has been horribly mismanaged, but those days are over. The Wilks family knows how to run a successful OFS business, and I think the company has turned the corner. In this environment I don't expect a big upside move in the case of a strong report, but it certainly be a case to take a position in the company at current levels if the news is good.
On a discounted cash flow basis, and using simple math, $2 bn in revenues over 10 years at a reasonable EBITDA, say $700 mm, would get you a share price of $9.09 per share at the current 77 mm share count. Fun with numbers! Any contributions from the JP-3 business would be additive to this figure.
Bottom line we remain positive on the company and think investors with a high risk tolerance may find the company attractive at or near current prices for long term growth. We are counseling patience ahead of earnings.
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