Basic Energy Services Inc. (BAS), is a well site service provider to oil and natural gas drilling companies in the United States. Based in Midland, Texas, Basic should benefit from strong demand for workover and drilling services in its core Permian Basin region due to growing strength in oil and natural gas prices, and its unparalleled well service utilization efficiency.
Basic Energy Services stands out from the crowd because its operating fundamentals have higher-than-average leverage to oil prices. Indeed, over the past five years, it has been seen that (on average) for every $1-a-barrel movement in the price of West Texas Intermediate crude, BAS stock moved 1.8x. This is a direct result of the company’s well servicing utilization (WSU) rate. In June, its WSU rate reached 74%, versus peer competitor Key Energy Services’ rate of 63%, and the industry average of 66%. (WSU measures the efficiency with which well servicing dollars generate oil and gas production dollars.) Basic’s WSU rate will likely remain in the mid-70% range for the second half. Third-quarter results will be released on October 20th.
Since the June highs of this year, the price of oil has fallen about 20%, compared to the stock price of Basic, which has dropped over 35%. This is because the cost of drilling becomes less economical as oil and gas prices fall. This compounds the negative effect on well service providers’ operations. But given the fact that we expect production activity in Basic’s flagship Permian Basin region to increase 20% in the next 12 months, and that we think the price of oil and natural gas is more likely to rise than fall, this equity has strong near-term upside potential.
Revenues are recuperating, and profits are materializing.
For the first time since the final period of 2008, Basic generated a bottom-line profit in the June quarter of $0.40 a share. We look for share net of around $0.65 in both the third and fourth quarters of this year, resulting in full-year share earnings of about $1.25. This compares to a bottom-line deficit of $1.10 in 2010. The top line reached an all time high of over $1 billion in 2008. Revenues were almost halved (to $528 million) in 2009. They rose to $728 million in 2010, and should top $1.2 billion this year. Sales are being spawned externally and internally. Externally, Basic recently acquired the Maverick Companies and Lone Star Anchor Trucking Inc. Two more acquisitions are in the works, and will likely close sometime either this month or next. The Maverick acquisition has helped Basic enter the small-diameter coiled tubing market. Further purchases should help it enter the more lucrative large-diameter coiled tubing arena. Internally, sales comprise four main categories. They are Completion & Remedial Services (40% of total sales), Fluid Services (28%), Well Servicing (28%), and Contract Drilling (4%). The Well Servicing business is the highest margin operation, and we expect this to benefit from increasing servicing efficiencies, in conjunction with growing revenue per rig hour, which is rising at a 5%-6% quarterly rate ($376 in the second quarter, compared to $356 in the March period). Completion & Remedial Services revenue should continue to increase at about a 9% quarterly clip, thanks to widening frac (and coiled tubing) spreads, as well as rental income from drilling tools. In the Fluids Services segment, revenue per truck ought to rise to $105,000, from $97,000 in the June (second) quarter, and $88,000 in the first period. Volume has also risen, thanks to the aforementioned Lone Star buy. Based on these numbers, we look for share net to increase from an estimated $1.25 in 2011, to $2.00 in 2012, and $2.65 in 2013.
Although long-term debt has grown recently (to fund acquisitions and capital spending needs), cash on hand has also ballooned (to $220 million at the end of the June quarter, compared to $48 million at 12/31/10). Long-term debt of $762 million is now 71% of total capital, up from 61% at the end of last year. Operating cash flow, however, is rising at a 21% average quarterly rate, thanks to enhanced sales and diminishing variable expenses. Long-term debt issues, which consist of 7.125% senior notes due April 2016, 11.625% notes due August 2014, and a 7.75% issuance due 2019, are all rated just below investment grade (at Baa).
At the current valuation, Basic has considerable near-term recovery potential. Investors should be aware, however, that this stock’s price is closely allied with, and highly leveraged to, oil prices, which are notoriously erratic. As such, we advise investors to keep a close eye on this issue. More conservative accounts may want to look at Basic’s corporate debt issues, which guarantee semi-annual coupons, and carry less risk than owning the common outright. Due to these debt issues, there is a covenant that prevents Basic from paying a common dividend. Similar companies to Basic in the small- to mid-cap arena, that offer a little more stock price stability, but less upside potential, are Parker Drilling (PKD), and Newpark Resources (NR).
At the time of writing, the author the author did not have positions in any of the companies mentioned.