Special Free Report From The Motley Fool
The Motley Fool’s #1 “HIGH ENERGY” Play Right Now
Thanks for taking the time to access my report. My name’s Iain Butler and I’m the lead Advisor of a service called Motley Fool Stock Advisor Canada.
In a moment, I’ll show you how to claim a heck of a deal on a subscription, should you be curious. Stock Advisor Canada is full of vital information and investment ideas that I believe will help you significantly grow your wealth over the long term. It takes you just a few minutes to read each monthly issue, but it could prove to drastically change your financial future.
But first, I want to reveal my favourite energy play right now. I believe these shares may represent an opportunity for 70% returns, if our thesis plays out like we expect. There are no guarantees, but I can tell you we certainly like the odds.
So, without further ado…
The Motley Fool’s #1 “HIGH ENERGY” Play Right Now
Pulse Seismic, TSX: PSD
|Market Cap:||CAD $164m|
|Data as of:||1/04/2018|
At The Motley Fool Canada, we’re generally not big fans of oil and gas exploration and production (E&P) companies, given their constant need to spend excessive capital to replenish depleting resources.
However, good businesses tied to the energy industry do exist.
Meet our current favourite – Pulse Seismic, TSX:PSD, a pure-play seismic data library company and, dare we say it, hidden gem. The business model is straightforward. Pulse makes money by repeated licensing its data library to various E&P companies to aid their resource replenishment quests. That’s it. No equipment fleets or field crews. No mess. Just data.
In a nutshell…
- Given the company’s strong balance sheet and limited operating costs, downside from here is fairly hard to imagine.
- Upside, however, is easy to picture. The current price of 11 times earnings seems more than reasonable for a company that has no financial risk but is highly variable.
- In fact, we believe this company is worth about $300 million in more normal times. That’s about $5.20 per share given current shares outstanding. Yet the shares have slid to $3.05 (as of 1/5/2018). All this translates to a potential profit of 70%, if everything goes right and our thesis plays out as we expect. Not too shabby!
A deeper dive into the business
Pulse’s data library represents a firm competitive advantage. If it’s known that seismic data for a desired area already exists, it’s not cost effective to re-shoot it; licensing from Pulse makes far more economic sense. Effectively, Pulse owns a non-replicable asset, with a competitive edge that grows as the library expands. The potential economics of Pulse’s business model are, frankly, staggering.
Yet even with its competitively-advantaged model, Pulse hasn’t been untouched by the downswing in the western Canadian energy space. It’s hard to keep powering ahead when your customers all run into a wall simultaneously. Total revenue, which exceeded $86 million in 2012, fell to just over $14 million in 2016.
But perhaps the most impressive thing about Pulse is its extreme shareholder-friendliness and management’s focus on the long-term health of the company. Consider how, as the oil patch decline set in, Pulse battened down the hatches and positioned itself for the possibility of an extended low-commodity-price environment. All debt was repaid. All capital spending remains 100% discretionary and aimed at growth.
The valuation and the investment case
The annual cash operating costs to keep the company’s lights on are approximately $6 million. Contrast that last point with the worst twelve-month period the company has faced during the current downturn – the $14.3 million revenue produced in 2016. Even during that worst of times, Pulse produced $9.1 million in cash EBITDA and $9.0 million in shareholder free cash flow (SFCF) – metrics that the company focuses on every quarter ahead of more traditional accounting-based metrics like earnings per share.
Pulse has two traditional licensing revenue tracks – “traditional sales” and “transaction-based sales.” The former tend to be roughly spread across the year and have averaged $10.6 million annually over the past three years of extreme downturn for the Western Canadian oil patch. Note that even this lowered level of activity is well more than the annual cash operating cost of Pulse’s business. Transaction-based sales can happen at any time and are generally triggered by corporate mergers, joint venture activity, or asset disposition activity by Pulse’s clients.
The energy downturn has seen transaction-based sales fall off as well, at least, that is, until last August when Pulse announced that it had signed a $29.5 million seismic data licensing agreement, surpassing its previous record individual data license of $27.8 million set in 2012 during the height of the last oil boom.
Given the “hunker-down” mode in which Pulse has been operating, this revenue largely dropped unencumbered to the operating profit line. From there, $7.5 million was apportioned for the taxman, $10.9 million was paid as a $0.20 per-share special dividend, a few million was added to the regular share repurchase program, and the rest piled up on the balance sheet. As of the end of 2017, there was roughly $20 million in cash (after taxes were paid) in the company’s coffers – nearly 1/8th Pulse’s market capitalization.
So you begin to see why we’re so convinced this company faces little financial risk – while the shares may appreciate as much as 70% if we’ve got this right. However, do keep in mind that there are risks. More on those, now…
Assessing the risks
The biggest risk we see in Pulse is the possibility of management abandoning the practices and methodology that have worked well so far.
If the company starts reaching for growth, levering-up and over-paying for seismic datasets, then fails to monetize, our investment thesis would be seriously threatened. Additionally, such behaviour would represent such a culture departure for management that we’d wonder what had flipped their switch (and we would ask them, too, since the company is small enough that we can just phone them up).
This risk, however, isn’t something we’re terribly worried about. Management’s long record of being conservative is reassuring, with past performance being a presumably reasonable indicator of the future.
An area of greater concern, perhaps, is if the possibility that Pulse could become a takeover target before we can fully benefit. Pulse is the second-largest owner of seismic data in the Western Canadian Sedimentary Basis, after privately-held Houston-based Seitel. If, for example, Seitel were to make an “offer they couldn’t refuse,” we might miss out on a significant part of the next industry upswing.
Finally, realize that Pulse is in a cyclical industry. When the next upswing does arrive (no predictions) and Pulse presumably rises in-line with the industry, be sure to keep one eye on valuation versus the oft-stated metrics of Cash EBITDA and SFCF. During the last run-up, these valuation ratios topped out at the 14x-to-15x level. It might be worth lightening up if similar levels are reached again, but only if such a valuation coincides with an industry run-up (in other words, don’t get faked out by such valuation levels if the industry stays in a slump).
The Foolish Bottom Line
With the presumed worst of the industry downturn now past us, expect Pulse to continue to generate significant cash flow above its bare-bones operating costs, with unpredictable “transaction-based sales” from time-to-time. Further, expect management to maintain its conservative stance and to continue using the company’s resources in the service of shareholders.
But then, what if something actually goes right and the industry picks up sharply? We don’t need that to happen because Pulse is worth buying today purely on its own merits. If it does happen, however, it’ll be all gravy.
I hope you’ve enjoyed this special report.
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Disclosure: The Motley Fool owns shares of Pulse Seismic. Returns as of 2 May 2018.