Special Free Report From The Motley Fool
Fellow Fools,
Let’s not beat around the bush – energy companies performed miserably in 2015.
Yet, even though the carnage was widespread, not all energy related entities are created equally. This is an important consideration, and top of mind for those of us that are keen to exploit the market’s broad strokes.
You’re about to meet a company that fits this mold perfectly, in our opinion. This is a company that is largely tied to the production of natural gas, even though its business is not actually producing natural gas. Instead, it plays a sizeable role, internationally, in building and providing the equipment required to get natural gas from the ground to the end user.
Given the increasing movement towards clean energy that’s underway, a movement that natural gas plays a significant role in, as well as the prevalence of natural gas around the world, we’re of the mind that this is a company square in the cross-hairs of rising, long-term secular demand for the services and products it provides.
Admittedly, our focus for this company is on the “- and Beyond” portion of the title as a 1-year move out of any stock is entirely unpredictable. We do however think that by purchasing this company while it’s been washed out with the rest of the energy industry, you could be setting yourself up for potentially sizeable long-term gains.
It’s these kinds of energy companies that we’ve focused on within Stock Advisor Canada and I’ll encourage you, after getting up to speed on this front, to see our other recommendations along similar lines.
Fool on!
Iain Butler, CFA
Chief Investment Adviser, Stock Advisor Canada
A global company whose products and services play a critical role in extracting the world’s vast natural gas reserves.
Why Buy:
- Products and services play a critical role in secular theme of natural gas extraction.
- A growing international platform provides unique positioning.
- Solid financials and proven history of dividend growth.
It’s no secret that the plunge in oil prices since the summer of 2014 has brought with it widespread losses in the Canadian energy sector. The commodity’s decline has been steep and swift:
The ensuing sell-off has been, too. The S&P TSX Composite Energy Sector has lost more than 35% since June 30, 2014. Carnage.
And though we generally admire Warren Buffett’s advice to “be greedy when others are fearful,” we still can’t get comfortable with the idea of recommending an energy producer.
However, we’ve picked through some of the wreckage — what emerged was our Top Stock for 2016 which comes from the energy services sub-sector. Both now, and looking forward, we believe Enerflex (TSX: EFX) offers a unique business, a global footprint, and, in our mind, an excellent long-term opportunity.
The Business
Enerflex has been providing oil and gas services since 1980, but up until June 2011 (when it was spun out) it did so embedded within Toromont Industries (TSX: TIH), which is primarily a Caterpillar equipment distributor.
Enerflex offers a unique business, a global footprint, and, in our mind, an excellent long-term opportunity.
The company’s offering supports the mid-stream and producing sectors of the energy world in the compression, processing, transformation, and movement of natural gas. Enerflex also provides full lifecycle service to the associated equipment and systems that it offers, and acts as a sizeable distributor of General Electric’s Waukesha gas engines. (Who doesn’t need a Waukesha?)
Enerflex’s products and services are part of the process of extracting natural gas from the ground and getting it into a pipeline and on its way to the eventual end users. Compression provides the pressure required to get the gas moving, while processing and refrigeration facilities strip out the various components of natural gas (i.e., liquids). This business benefits from a global increase in natural gas volumes – a potential worldwide secular theme.
Enerflex operates in three main geographic areas: Canada (30% of revenues); the United States (42% of revenues); and the Rest of the World (28% of revenues). Engineering systems — that is, the compression and processing facilities that Enerflex builds and installs — accounted for 67% of 2015 revenues. Service and rentals, which offer a more recurring (and higher-margin) revenue stream, represented 24% and 9% of last year’s revenues, respectively.
A Possible Game Changer
Back in June of 2014, Enerflex announced the acquisition of Axip Energy Services’ international operations, which consist of contract compression and support businesses. These businesses were acquired from private equity firm TPG Capital for US$430 million. Cash on hand and an expanded credit facility were used to finance the deal.
As part of the transaction, Enerflex acquired 285,000 horsepower (HP) of compression rental assets. These assets have historically operated at a more than 90% utilization rate and have between 3-7 years of contract term still outstanding. In addition, three gas-treating facilities were also acquired. The largest is located in Mexico, with the other two located in Peru and Argentina.
The addition of the rental assets and the recurring revenue they provide will help management to achieve its goal of deriving 35%-40% of the company’s top line from service and rental-related revenues (up from 27% in 2014 and 33% in 2015). As indicated, the rental and service business is also higher-margin and should add a measure of stability to the bottom line, as the company’s engineering systems work tends to be project-oriented and therefore lumpy.
Longer term, this deal potentially opens up new geographic markets for Enerflex — which could make the growth story really interesting. Management indicated that historically, 70% of Axip’s international revenues were derived from Mexico, a country that is undergoing significant evolution in its energy industry. In addition, the deal provides Enerflex with a beachhead in Argentina, Brazil, and Peru, as well as enhancing its position in Bahrain, Colombia, Malaysia, and Indonesia.
Longer term, this deal potentially opens up new geographic markets for Enerflex — which could make the growth story really interesting.
The company’s global footprint serves as an advantage thanks to the diversity it provides, and the Axip deal only appears to have bolstered this advantage.
Gas-A-Palooza
While international expansion opportunities are intriguing, the entire natural gas industry has experienced somewhat of renaissance. Thanks to improved drilling techniques, the amount of natural gas that is available in North America alone is staggering. According to the company, there is 600 trillion cubic feet (trillion!) of natural gas in the U.S. that can be developed for less than $5 per million cubic feet (MCF).
Although supply appears virtually unending, what’s critical is the evolution of demand to soak it up – a process that will take time.
Standing front and centre on the demand side of the equation is the continued build-out of a global liquefied natural gas (LNG) trade. This would see increasing levels of natural gas floating (literally, as LNG is seaborne) from the energy-rich countries of the world (i.e., Canada, the U.S., Australia) to energy-poor markets that are populous and economically growing. Enerflex does not build LNG facilities, but it does provide the equipment necessary in treating, processing, and transporting natural gas between the wellhead and the export pipeline.
The thing is, building out this LNG trade is tough. These are massive, expensive, long-term undertakings involving many, many different stakeholders who bring all kinds of views and motivations to the table.
LNG is not the only potential source of incremental demand for natural gas. Others include increased consumption for power generation due to switching from coal-fired generation, greater consumption for industrial uses such as fertilizer and petro-chemicals, and the potential for fuel shifting in the transportation sector.
The same risk hovers, however — things like power plants and fertilizer facilities are not going to spring up overnight.
Valuation
Along with its peers in the energy sector, Enerflex has pulled back right along with the energy sector – its shares are down by about 46% since June 2014. Because of its almost exclusive exposure to natural gas, and the fact that fundamentals on this side of the industry have not necessarily shifted like they have for oil, in our opinion, this decline seems relatively unwarranted.
With that said, as the chart below conveys, prior to the decline, Enerflex was trading with some lofty multiples, at least relative to past earnings. This probably isn’t a company we’d be recommending were it still trading with a price-to-earnings (P/E) ratio north of 40.
Enerflex’s P/E since September 2011.
Things look even better when we consider that Enerflex offers a dividend yield of 3.02%, and management has steadily hiked the dividend from a quarterly rate of $0.06 in 2011 to the current quarterly payout of $0.09 ($0.36 annualized).
Foolish Bottom Line
By adding to its recurring revenue streams, Enerflex’s underlying business has gained an increased degree of stability over the course of this year, but there’s little doubt in our mind that the more project-focused work is likely to continue carrying the flag for this company. Because of the nature of this work, there are likely to be good quarters and bad ones in the coming years, and therefore, to own Enerflex, patience is a prerequisite. While the shares may snap back if a broad energy-related rebound occurred, that’s not why we’re recommending this company. (Turn to the producers if that’s the kind of action you’re after.)
Similar to other energy equipment and services-related stocks out there, we think Enerflex has a great business and offers a unique way to gain exposure to the continued evolution of the global energy industry. After all, for each and every new well that is drilled, Enerflex’s services are likely to be required in one way or another.
The company isn’t going to win every bid, of course, but we think its track record, focused model, and expanding geographic footprint put the company in very good stead to play a significant role in this evolution.
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All figures as of August 8, 2016.
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