The fourth quarter of last year marked the end of a two-year dry spell in initial pub­lic offerings (IPOs) in the oilfield ser­vices sector. The two companies that came to market varied markedly in their operations, one being highly diversified, while the other was built around a single asset. But both shared a common theme in that, in a market averse to leverage, their post-IPO balance sheets were essentially debt-free.

Mammoth Energy Services LLC (NYSE: TUSK) priced at $15/share, the bottom of its expected $15 to $17 price range, and raised $116 million. Mammoth, based in Oklahoma City, is a provider of completion and produc­tions services—an area where few smaller frack firms can claim to be debt-free—as well as proppant logistic services, contract and directional drilling services and remote accom­modation services.

Completion and production services account for roughly 70% of Mammoth’s, with the com­pany’s primary area of operations centered in the northeast, according to a Credit Suisse research report. Most of the work is done for Gulfport Energy Corp., which post-IPO owns 24.2% of Mammoth, it said. The two compa­nies have long-term contracts covering pressure pumping through September of 2018.

Both Mammoth and Gulfport trace their roots to hedge fund/private equity sponsor Wexford Capital, according to Credit Suisse. Post-IPO, Wexford retains a 55% interest in Mammoth, although it no longer holds a sig­nificant stake in Gulfport, noted Credit Suisse.

The relationship between Mammoth and Gulfport can be seen from either side. On the one hand, Mammoth derives 45% to 50% of its revenue from Gulfport, presenting an issue of concentration risk. On the other hand, with a 24.2% stake in Mammoth, Gulfport has a vested interest in maintaining its strong rela­tionship with the oilfield service provider as it continues to expand its E&P operations.

Mammoth benefits from take-or-pay con­tracts with Gulfport covering two frack fleets whose pricing is said to be “well above the spot market,” according to a research report by Simmons & Co. Running through September of next year, these contracts provide a “stability which several of Mammoth’s peers do not enjoy,” Simmons noted.

“The key question will be the crossroads at which the Gulfport contract expires and the industry utilization/pricing at that time,” observed the Simmons report. While expiration of a premium-priced contract is an inherent risk, “our current call is for rising utilization and pricing for the U.S. frack industry,” it said. “Because we see market conditions improving, we are comfortable with the time frame of the Gulfport contract expiration.”

In the meantime, on its third quarter confer­ence call, Mammoth announced plans for an additional 75,000 horsepower to be added to its pressure pumping fleet. The company identified the Scoop/Stack as one of several plays where the equipment could be deployed. Separately, Gulfport announced an agreement to acquire Vitruvian II Woodford LLC, with operations focused on the Scoop, for $1.85 billion.

Research reports offer target prices that reflect, in part, the degree to which the firms’ analysts hold a more or less bullish commodity outlook.

Raymond James recognized that, with its commodity price deck for West Texas Interme­diate (WTI) at $80 per barrel in 2017, it held a “well-above-consensus view of crude oil prices next year.” Its initial rating on Mammoth on Dec. 16 was Outperform, with an $18/share target price, noting that oil prices tend to be “the largest driver of stock price movements,” both in the short term and long term.

“At these commodity levels, U.S. E&P activ­ity increases will be dramatic, as spending is poised for a massive uptick of over 100% growth year-over-year,” Raymond James pre­dicted. “This should support a recovery in U.S. land activity and allow Mammoth to capitalize on its uncontracted business.” Mammoth is expected to have three pressure pumping fleets operating on the spot market by late 2017, it noted, adding to its high-margin, two-fleet con­tract with Gulfport through the third quarter of 2018.

“Pressure pumping utilization and pricing is on the horizon,” according to Raymond James, “and we expect these fleets will gar­ner significant increase in utilization, pricing and margins, given our outlook for significant capacity bottlenecks.” The company’s com­pletions business, coupled with its frack sand logistics services, account for about 90% of its projected enterprise value, it noted.

“While many investors may be concerned about the wide mix of business lines involved, we see the majority of the value in its comple­tion leverage,” Raymond James added. “Fur­ther, the company’s debt-free balance sheet allows the company to take advantage of the downturn and organic growth opportunities.”

Weight and see

With the stock having closed at $15.45 on Dec. 20, its price already discounts some of investor concerns, said Raymond James. “Cur­rently, the stock trades at a two-turn discount to its peer group on its ratio of Enterprise Value-to-estimated 2018 EBITDA (EV-to-EBITDA), which we see as unwarranted given the clear balance sheet and completions lever­age. All in, our valuation is attractive at $18 per share, and we expect strong growth in the recovery.”

Other firms had less aggressive target prices, while echoing the pressure pumping leverage offered by Mammoth and its strong balance sheet. Credit Suisse rated the stock Outperform in a Nov. 11 report in which it assigned a $17 target price, while Simmons gave Mammoth an Overweight rating with a $16 target price in a report dated Nov. 20.

Simmons noted that other publicly traded pressure pumpers that have “palatable balance sheets” trade at well above the 6.0x multiple of EV-to-2018 EBITDA upon which its $16 target price for Mammoth is based. “Our Overweight rating largely reflects the virtues of Mammoth’s debt-free balance sheet,” said Simmons, adding: “Mammoth has scarcity value as one of the few names in our coverage universe that has frack exposure, screens mod­estly undervalued and is debt-free.”

In an earlier report, Simmons noted that Mammoth’s disparate product service lines appear to “offer little synergies,” which may result in a “conglomerate discount” in terms of valuation by investors. But higher rig count activity is expected to drive increased well completions, a key factor for several of Mammoth’s business segments, particularly pressure pumping, coiled tubing and proppant distribution.

Revenue from the company’s comple­tion and production segment is expected to improve by roughly 100% in 2017, as Mam­moth deploys its third frack fleet in 2017 and further expands the segment with its recently announced purchase of new pressure pumping equipment, according to Simmons. “Given its strong balance sheet, Mammoth will likely pursue M&A as well,” the note added.

Tudor, Pickering, Holt & Co. (TPH) assigned a Hold rating to the stock in a report dated Dec. 15 in which it gave a price target of $14 to $19. Pressure pumping is expected to drive the lion’s share of the growth in reve­nue and EBITDA for Mammoth, it noted, but a comparison with its pressure pumping peers does not indicate a steep enough discount to add aggressively based on EV-to-2018 EBITDA, it noted.

“On this metric, Mammoth does trade at a slight discount to peers, but we think this is warranted given Mammoth’s limited scale vs. primary peers, its lower-tier assets outside of pressure pumping, and execution risk in initial stages of being a publicly traded company,” the Tudor Pickering report said.

As for execution risk, the report noted that “while there has certainly been no evidence of any hiccups on the execution front to date, we view execution risk as the biggest poten­tial investment risk for Mammoth moving forward, which is only natural for a newly public, small-cap company with a large appe­tite for inorganic/organic growth.

"Per management commentary, we think the company is currently evaluating well north of 25 potential deals, largely focused on comple­tions-oriented oilfield services end-markets, like pressure pumping and proppant services,” the report continued. “Picking and choosing between the right assets at the right prices will be crucial to the Mammoth story moving forward, as will successfully integrating any potential acquisitions into the current Mam­moth portfolio.”

Looking at logistics

While proppant logistics services are only part of Mammoth’s business, proppant sup­plies make up the entirety of the operations of The Woodlands, Texas-based Smart Sand Inc. (NYSE: SND). The Northern White producer went public last November, pricing an offering of 11.7 million shares at $11 per share, below the initial expected price range of $15 to $18 and comprised primary shares only (i.e., no selling shareholders).

“A large scalable asset was priority number one” for the Smart Sand management, accord­ing to TPH in a report dated Dec. 7. Smart Sands’ Oakdale mine in the western part of central Wisconsin sits on roughly 1,200 con­tiguous acres with 244 million tons of proven reserves and a production capacity of 3.3 mil­lion tonnes per annum (mtpa), it noted.

“This is a very large, scalable asset, espe­cially when you consider that many competitor mines sit on 20-30 million tons of reserves and have over 1 mtpa of true productive capacity,” noted TPH. “Management believes the mine can be built out to produce 9 mtpa, which would make it equal to the largest frack sand mine that we’re aware of. They certainly have the land and reserves to do so.”

While TPH commended the Oakdale facility as a “unique, low-cost, scalable asset,” which Smart Sand’s management believes could drive down operating costs toward $11 per tonne, it also observed that the company “has some heavy lifting left to do to improve its logistics footprint.” Currently, the company sells 100% of its volumes FOB (free onboard) the mine, it said, “as they do not own or lease a transload/last mile solution for the customer.”

Given a clean balance sheet, this down­stream logistics issue—potentially a “growth headwind in a tight market”—is one that Smart Sand management is “focused on rem­edying,” according to TPH. “We believe a clearly articulated glide-path to an improved logistics footprint would boost the company’s valuation in many investors’ eyes.

The origin logistics setup at Smart Sand’s Oakdale facility is, by contrast, likely the envy of most sand miners, said TPH. With its origin terminal designed to load more efficient unit trains, Smart Sand estimates it could load 1 mtpa of frack sand with roughly 300 rail cars given the facility’s existing logistics setup, whereas most competitors would likely need between 700 and 1,000 rail cars.

Customer concentration is an issue for Smart Sand, albeit of lesser importance as customers tend to show willingness to sign term contracts, according to analysts. In the past, contracts have enabled the company to generate positive EBITDA—even during the first half of 2016—but the ability to re-nego­tiate contracts and/or sign new contracts poses a risk.

Three customers accounted for 85% to 90% of revenues in the first half of last year, according to TPH. One of these, Weatherford International Plc, accounting for 33% of reve­nues in the first six months of 2016, is said by numerous industry sources to be suspending pressure pumping operations. The contract with another major customer, EOG Resources Inc., expired in November of last year.

However, concerns over customer concen­tration are largely allayed by improving fun­damentals prevailing in the frack sand sector. For example, TPH forecast that consumption of frack sand could more than double by 2018 vs. the prior peak year of demand in 2014, with consumption growing to 120 mtpa next year from 54 mtpa four years earlier.

Growing demand is translating into interest in term contracts, according to a Credit Suisse report published following Smart Sand’s first quarterly report as a public company.

“Customers are increasingly interested in signing term contracts, with durations from one to five years, which is an indication of the need to lock in assured supplies of sand going into 2017,” said Credit Suisse. “Con­tract pricing is being indexed to various metrics (including oil price and rig count), providing Smart Sand with assured volumes without locking in pricing near a cyclical bot­tom. Smart Sand’s reserve base is over 80% fine mesh sand, which is in most demand,” it added.

In addition to production costs coming in at a favorable $11.43 per tonne, Credit Suisse pointed to a new contract signed by Smart Sand with Rice Energy Inc. Similar to terms of Smart Sand’s other contracts, the new deal is “structured as a take-or-pay agreement and includes a monthly, non-re­fundable reservation charge.”

While no specific financial details were dis­closed, “it was mentioned that Smart Sand will have 1.6 million tonnes of annual production under contract, which in our model implies 400,000 tonnes per annum,” it said.

“On pricing, we assume $25/ton in 2017 and spot pricing thereafter (average of $35/ton in 2018),” said Credit Suisse.

Moving targets

While the expiration of the EOG contract in November was “certainly not good news,” statements by Smart Sand indicated that EOG continued to take volumes at a price in line with prior contract terms, noted Credit Suisse. The report cited Smart Sand EVP of Sales and Logistics, John Young, who said, “We expect to continue to have them [EOG] as a long-term customer. And with regard to EOG, I think, as they have more clarity into their plans for 2017 and 2018, we expect to be part of their supply chain.”

While focusing on Smart Sand’s “lack of logistics capability” as a concern, Credit Suisse said that the Oakdale mine’s location near two Class 1 railroads was “a clear positive.” In addi­tion, the company is evaluating transload capac­ity that “best suits customer location demand,” it said, and “being a bit late allows for fewer mis­steps, greater capacity options and optimization of the supply chain, all of which should serve to boost the valuation over time.”

In an early 2017 report, Credit Suisse increased its price target for Smart Sand to $18, up from $16 previously. The higher target price reflected 2018 forecast EBITDA edging higher to $87.8 million, up from $86.9 million, and Credit Suisse bumping up its target multiple of EV-to-2018 EBITDA to 8.5x, up from 7.5x earlier. This followed Smart Sand’s contract win with Rice Energy and the fact that EOG continued to take volumes in spite of the con­tract expiration.

Other firms have also raised their price tar­gets. Simmons increased its price target to $19.25, up from $13.25 previously, on higher projected 2018 EBITDA and a move higher in its target multiple, “as our prior concerns regarding customer concentration appear to be mitigated by rapidly improving fundamentals, including higher spot prices.” Simmons’ target multiple was raised to 9.0x EV-to-EBITDA, up from 8.0x previously.

TPH’s price target is $15 to $19, based on a 7.0x to 9.0x multiple range of EV-to-2018 EBITDA. This is lower than an EV-to-2018 EBITDA range of 8.0x to10.0x used in setting price targets for proppant producers Fairmount Santrol Holdings Inc. and Silica Holdings Inc. However, TPH still sees significant upside potential for Smart Sand.

“Should Smart Sand improve its logistics platform, grow volumes faster than we antici­pate and catch up to peers like Silica Holdings and Fairmount Santrol on the logistics front, we believe the company’s earnings and EV-to-EBITDA multiples would both climb; in this scenario, we could see stock upside to $20-$25/share,” it said.

Comments