SS: If you rewind a year, the company had just acquired Calgary Tunnelling. It hadn't even picked up Hart or Westar, which were acquired in January and October of this year, respectively. We're only beginning to see the company's ability to manage the diversity of the companies it now has under its umbrella.
We know that Enterprise is expanding its fleet to meet substantial demand, but following Q3/14, which the company reported on Nov. 12, the market has tempered its expectations as to how quickly that will occur. We reduced our target price from $1.50/share to $1.10 in response to a reduced margin profile, which is a function of managing its many subsidiaries' equipment fleets. The company has a variety of equipment spread across Alberta and B.C. right now. I think the market had anticipated a quicker ramp-up and quicker margin accretion than was feasible on the ground.
In Q3/14, we got EBITDA (earnings before interest, taxes, depreciation and amortization) margins of about 24%. The market was looking for 30–31%. The difference was the result of an extensive use of third-party equipment in the quarter. What that showed us is that the company has the capacity, with all its acquisitions, to service the client base, but that it just wasn't there in terms of leveraging that capacity effectively to meet the demand. It had to rent equipment from a third party, and then rent it out again to meet demand. Enterprise is managing acquisitions, but I think the market has rightfully tempered its expectations.
TER: Your $6/share target for Xtreme Drilling looks like a moon shot given its decline since the summer. How do you justify your Buy rating?
SS: In July, the stock was well above $5. Now we're talking about $2/share, with the only fundamental change at the company level being higher day rates on its coil units and an up-and-running, two-rig Indian program, both of which are positive events. I think this shows just how levered driller names are to the oil price.
Our Buy rating is still justified by a few things. The company has just over 7,000 contracted days on its XDR rigs, representing revenue of about CA$225–235M. That's 75% of 2015 contracted days already locked in, which provides a lot of cash flow certainty—much more than Canadian drillers can say for themselves. In Canada, Xtreme is going to get hit a little harder simply as a function of the fact that the seasonality is very different, with spring break-up, and the fact that the company operates on a well-to-well contract versus long-term contracts, which Xtreme can achieve in the U.S.
Also, a foundational component of Xtreme is its coil unit business. It's seeing day rates actually increase as oil prices decline. Producers are increasingly cognizant that they need to optimize well productivity and achieve the netbacks to stay profitable in a declining oil price. Xtreme has consistently demonstrated that its coil is the most efficient, and its rates are competitive. Recent rig data shows that Xtreme's U.S. fleet drilled the most footage per month per rig in the U.S. It was at almost two times the average. That substantial efficiency increases profitability for the producer. Should there be long-term concern on rigs the company has in more exposed basins, Xtreme has noted it has optionality to move rigs to India and other international markets, where the company garners more premium day rates.
When oil comes off, usually the shallow-depth rigs get hit first. That class of rigs has been more commoditized, and they're more replaceable. Xtreme has only a couple of shallow-depth rigs in its fleet, which we expect will get hit as oil prices come off. Those are the ones that it can easily move internationally.
TER: Northern Frontier acquisition plans are pretty ambitious in all three of its service areas. What are your expectations for this company?
SS: For Northern Frontier we're looking for some near-term calm. The company has a buy-and-build strategy, but at this oil price and the way the stock has traded, we and management both are looking for execution. A couple of months ago, when it was going for its most recent acquisition—of Central Water & Equipment Services Ltd.—the first financing, a wholly debt financing, had to be terminated. Then Northern Frontier came out with a second round. The company ended up utilizing a combination of debt, equity and stock. The equity came in at a little more than what the market anticipated, so it ended up being a dilutive transaction. Subsequent to that, the stock price did fall off a bit.
The deal was priced at $2.15/share. The stock is at $0.60/share now. This is a function of the financing mechanics. Q2/14 was also reported well below expectations, as a function of the weather in the area where it operated, primarily in the Fort McMurray area of Alberta. Then a perfect storm hit, with declining oil prices taking the stock down from the deal price of $2.15/share.
People feel burned, and the company knows that it needs to execute now, and prove out the businesses to a point where it can carry out further transactions. We believe that, over time, Northern Frontier will execute and meet our expectations, and as we mentioned earlier, a focus on maintenance and sustaining services should insulate the name within the current oil price environment.
TER: What effect will the Halliburton/Baker Hughes deal have on these companies, if it goes through?
SS: Baker Hughes and Halliburton have minimal presence in Canada. Northern Frontier and Enterprise Group will not feel the impact of their operations. However, Xtreme, which primarily operates in the U.S., could. It's important to say at the outset that Xtreme already works for both Baker Hughes and Halliburton. The company recently deployed two rigs to India; those are actually working through Halliburton.
Xtreme has a stronger relationship with Halliburton's groups than with Baker Hughes. In the event of an acquisition closing between those two parties, should the project management groups consolidate and the right people from Halliburton step into the roles of the combined entity—which we see as highly likely given that Halliburton's group is substantially larger, is more effective, and has a much greater scope, not to mention that Halliburton is acquiring Baker—that would bode well for Xtreme in terms of the amount of work that it is awarded. Either way, Xtreme's work through Baker and Halliburton is not substantial. Any material change would be incremental.
TER: Let's move on to something entirely different. Can you tell us about another company you have under coverage in a different sector?
SS: Yes. We cover Input Capital Corp. (INP:TSX.V), the first and currently only agricultural streaming company in the world.