Editor's Choice

This Canadian Oilfield Service Company Isn't in Bargain Territory

Nathan is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

One of the new oilfield service players is Canyon Services Group (TSX: FRC) whose revenue stream relies heavily on hydraulic fracturing. Does an investment in Canyon have a strong upside potential from the current levels? Let's take a look under the hood to check it out. 


According to Canyon, the Canadian pressure pumping market has been impacted by weaker producer activity and equipment capacity additions. The trend of weak producer activity and pricing pressure of 2012 continued into 2013, and Canyon expects tough pricing for the remainder of this year.

Actually, the last fifteen months have been a depressive period for most of the oilfield service companies with operations in North America. In North America, the demand for oilfield services is flat or trending downwards, and fierce competition undermines the pricing power of the domestic players, eroding their margins.

Even oil services giant Schlumberger issued a warning recently stating that North American drilling activity and rig count in 2013 is lighter than it expected. Schlumberger's CEO also added that, "We continue to see negative pricing pressure in many product lines in Q1 2013, with active participation from our principal competitors, reinforcing the somewhat unclear outlook for the North America land market at this stage." 

So what? 

In 2012, Canyon's revenues and net income decreased substantially. EBITDA margin also plunged from 42% in 2011 down to 30% in 2012. This situation was carried over Q1 2013. The revenues decreased by 36% on a year over year basis, the profit fell down to $8.5 million, and EBITDA margin dropped further down to 23%.

From a valuation perspective, Canyon trades at PBV=2.2. With estimated EBITDA for 2013 at ~$71 million, the company's current enterprise value is ~10 times its EBITDA, which is a rich premium to its peers as shown below:

<table> <tbody> <tr> <td> <p><span><strong>Company</strong></span></p> </td> <td> <p><span><strong>PBV</strong></span></p> </td> <td> <p><span><strong>EBITDA</strong></span></p> <p><span><strong>Margin</strong></span></p> </td> <td> <p><span><strong>Net Debt / EBITDA</strong></span></p> <p><span><strong>(annualized)</strong></span></p> </td> <td> <p><span><strong>EV / EBITDA</strong></span></p> <p><span><strong>(annualized)</strong></span></p> </td> </tr> <tr> <td> <p><span><strong>Calfrac Well</strong></span></p> <p><span><strong>Services</strong></span></p> </td> <td> <p><span>1.7</span></p> </td> <td> <p><span>16%</span></p> </td> <td> <p><span>1.59</span></p> </td> <td> <p><span>6.86</span></p> </td> </tr> <tr> <td> <p><span><strong>Trican Well</strong></span></p> <p><span><strong>Services</strong></span></p> </td> <td> <p><span>1.53</span></p> </td> <td> <p><span>14%</span></p> </td> <td> <p><span>1.94</span></p> </td> <td> <p><span>8.4</span></p> </td> </tr> <tr> <td> <p><span><strong>Cathedral Energy Services</strong></span></p> </td> <td> <p><span>1.24</span></p> </td> <td> <p><span>16%</span></p> </td> <td> <p><span>1.6</span></p> </td> <td> <p><span>6.4</span></p> </td> </tr> </tbody> </table>

Calfrac Well Services (TSX: CFW) and Trican Well Service (TSX: TCW) are the two largest Canadian frackers by horsepower available. 

Both companies invest heavily in their international operations. According to a corporate presentation, Trican expects a strong second half of 2013 with revenue at its Russian operations increased by approximately 20% this year. Trican's first quarter financial results were also strong in Kazakhstan for the two fracturing crews operating in the region. 

Calfrac recently experienced further increases in the number of horizontal multi-stage fracturing treatments performed in Mexico and Siberia, where operating margins will improve in the second half of 2013 as weather becomes less of a factor. Furthermore, Calfrac completed the deployment of fracturing equipment into Argentina where it commenced fracturing operations in May 2013. 

Cathedral Energy Services (TSX: CET) is another fracking provider that invests in the U.S. to offset its weakening Canadian operations. Cathedral is in a position to access and exploit all major plays including the Bakken, Niobrara, Marcellus, Eagle Ford, Permian, and Piceance, where it continues to see opportunities to deploy additional units for the remainder of 2013. Cathedral recently initiated a buyback program, as it believes that the trading price of its common shares doesn't accurately reflect the value of the company. 

Now what ? 

The three potential catalysts that could help Canyon reverse the downtrend of its top- and bottom-lines are:

1. Drilling activity is likely to ramp up on the Montney and Duvernay formations after the recent deals:

  • PetroChina made a JV with Encana (NYSE: ECA). PetroChina gained a 49.9% interest in Encana's 445,000 acres in the Duvernay play for total consideration of C$2.18 billion. About half of it was paid on closing, with $1 billion payable over the next four years in the form of carrying half of Encana’s development costs. The two companies plan to invest a total of $4 billion in new drilling, completion and processing facilities as Encana estimates its holdings contain roughly 9 billion barrels of oil equivalent in place. This arrangement is expected to help Encana more than double its planned pace of development in the Duvernay.
  • Petronas acquired Progress Energy which is holding a large position in the Montney shale gas play.
  • ExxonMobil acquired Celtic Exploration that owns significant acreage in the Duvernay and Montney shale in Alberta. 
2. The Liquefied Natural Gas (LNG) projects off Canada's west coast and the very LNG-oriented type activity. However, none of these three projects (Douglas Channel, Kitimat LNG, LNG Canada) have reached final investment decisions to enter the construction phase so far. There needs to be a lot of consensus building and government approvals before the infrastructure building begins.
3. Canyon has zero international exposure and this needs to change. Demand exceeds supply in several African and South American countries that ramp up their oil production. These favorable supply/demand fundamentals keep the day rates up and the EBITDA margins high. According to Tuscany International Drilling, Africa and South America are largely unexplored and the local E&P companies receive Brent pricing that spurs them to drill. As Tuscany International Drilling also notes, the day rates in Africa are even larger than Latin America's. The icing on the cake is that the current supply shortage in these markets doesn't seem to change any time soon because a rig isn't built overnight. 

Foolish bottom line 
Canyon has to expand its service offerings and diversify the sources of its revenue to buck its weakness in Canada. Until some concrete signs of change show up, the company's valuation can implode any time; so a bullish bet on Canyon at the current levels carries high odds of flat or negative return. 


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Nathan Kirykos owns shares in Tuscany International Drilling. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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