A Fracking Stock Worth Its Weight in Oil

07/05/2012 9:45 am EST

Focus: GLOBAL

This small Canadian operation has come a long way since the beginning of the year, and that's just the first step in its growing fortunes, notes Marc Johnson of The Investment Reporter.

Since we last examined oil service stocks in February, San Francisco-based URS Corp. (URS) came to the same conclusion we did. It has acquired Flint (Toronto: FES) for $25 a share. That was up by 69.5% from the $14.75 a share Flint traded at when we published our February 24 issue.

In our March 2 issue, we examined URS Corp.’s takeover bid. We pointed out that Flint’s management planned to tender their shares. We wrote, “Since that’s what they’re doing and they know the company best, you should do likewise.”

To replace Flint, we’re adding Calgary-based Canyon Services Group (Toronto: FRC) to the oil service stocks that we regularly examine on The Back Page. It provides fracturing and chemical stimulation services for oil and natural gas exploration and production throughout the Western Canadian Sedimentary Basin.

In the three months to March 31, the company earned 90% of its revenue from hydraulic fracturing services. Other services include coiled tubing, nitrogen fracturing, "acidizing," and remedial cementing. Canyon is a buy for long-term gains and attractive dividends. But only if you can accept buying a company we rate "Higher Risk."

Canyon’s Shares Look Undervalued
In 2012, Canyon is expected to earn $1.62 a share. That’s up by 5.9% from $1.53 a share last year. Based on this estimate, the shares trade at an appealingly low price-to-earnings, or P/E ratio of only 5.6 times.

Keep in mind, too, that Canyon’s earnings estimate could prove too low if its strong first-quarter results carry over into the rest of the year. Next year, Canyon’s earnings are expected to jump by another 17.3% to $1.90 a share. This means that the shares trade at a cheap P/E ratio of just 4.8 times. Canyon’s price-to-cash-flow ratio is also attractive.

In the three months to March 31, its cash flow jumped by 21% from a year earlier, to $58 million. Over the latest four quarters, the company generated cash flow of $166.9 million. Divide this by shares outstanding of 61.1 million and you get cash flow of $2.73 a share.

Divide the share price of $9.05 a share by this and Canyon’s price-to-cash-flow ratio is 3.3 times. A ratio below 5 is sometimes a buy indicator. We believe that such is the case for Canyon. On the other hand, standard valuation tools are less useful when it comes to cyclical stocks.

Canyon’s strong cash flow also enables it to pay juicy dividends. On March 6, it raised its dividend to a yearly 60 cents a share. That’s up by 140% from the former rate of 25 cents a share. The new higher dividend yields more than 6.6%.

Canyon’s High Dividend Is Sustainable
While the dividend’s yield is high, we expect Canyon to maintain it. After all, the company’s growing earnings easily cover the dividend.

Also, companies usually raise regular dividends only if they expect to maintain them. If a company is unsure about whether its dividends are sustainable, it’s more likely to declare a one-time "special" dividend. The main point is that you can earn a great dividend while you wait for Canyon’s share price to rise.

Canyon’s focus on rewarding its shareholders is only natural. That’s because management owns 6.6% of the shares, so they profit from investor-friendly policies. Management’s significant stake in the company makes their interests similar to yours.

Another plus is that Canyon has no net debt. Its cash of more than $17.1 million comfortably exceeds total debt of less than $5.5 million. This improves the company’s safety and gives it financial flexibility.

Canyon Did Far Better in the First Quarter
Canyon got off to a strong start in 2012. In the first quarter, it earned $37.2 million, or 59 cents a share. This was up by 22.9% from $30.1 million, or 48 cents a share, a year earlier.

While revenue rose quickly, the cost of services rose even faster. Particularly the costs of materials, products, transportation, and repairs. The company’s tax rate fell by nearly 1.5 percentage points.

In the first quarter, Canyon’s revenue jumped by 37.3%, to $136 million. This largely reflects the benefits of its growth. In late 2009, the company’s pumping capacity was 25,500 hydraulic horsepower, or HHP. In the first quarter, its capacity had risen close to sevenfold, to 175,500 HHP.

Canyon is continuing to expand. It writes that its pumping capacity “will grow to 225,500 HHP by summer 2012 following completion of the 2012 capital program.”

What’s more, all the equipment added since 2009 is geared to high-demand areas where pumping pressure, rates, and durations have risen sharply. Canyon’s larger capacity enabled it to complete 934 jobs in the first quarter—up from only 736 jobs a year earlier. Even better, the average fracturing revenue per job climbed by 18.9%, to $232,279.

The company writes that “This increase was due to larger job sizes as the horizontal sections of wells lengthened, resulting in a higher number of fracture sections per well and larger, high-rate treatments.”

Canyon’s second-quarter outlook is favorable. That’s because the spring break-up took place sooner than expected. This caused the deferral of many completions programs. The company writes that this “is expected to augment demand for fracturing services when industry activity again resumes later in [the second quarter of] 2012.”

The outlook for the third and fourth quarters are subject to more uncertainty. The price of oil has flirted with $80 a barrel. And natural gas remains low at $2.65 per thousand British thermal units. This largely reflects a glut of natural gas.

To the extent that lower prices reduce demand from the oil and natural gas companies, oil services stocks could suffer. One slight offset it that the lower loonie will improve returns to Canadian producers. Buy Canyon Services Group.

Subscribe to The Investment Reporter here...

Related Reading:

Get Ready for a Slew of New MLPs

5 Good Starts When Looking for Income

2 Alternative Energy Income Streams

Related Articles on GLOBAL