CYPRESS ENERGY PARTNERS LP CELP
April 01, 2014 - 11:50am EST by
angus309
2014 2015
Price: 21.60 EPS $0.00 $1.40
Shares Out. (in M): 12 P/E 0.0x 15.4x
Market Cap (in $M): 255 P/FCF 0.0x 9.8x
Net Debt (in $M): 75 EBIT 0 26
TEV ($): 330 TEV/EBIT 0.0x 12.6x

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  • Oil and Gas
  • MLP
  • Oil Services
  • Shale
  • Energy

Description

I am recommending a long position in Cypress Energy Partners LP. Cypress (CELP), a recent IPO, which is the first public MLP with its primary "hard" asset being salt water disposal wells (SWD's). The stock might remain weak into its first quarterly report due to the harsh winter in the Bakken (lower volumes), but longer term, I like this nefirst mover in a highly fragemented area of oilfield service (SWD), with solid managment at the helm. Founded in 2012, CELP is a growth oriented MLP with headquarters in Tulsa, Oklahoma.
 
I'll touch a bit on SWD in general, then more specifically on CELP and it's other line of business.
 
Saltwater Disposal Well (SWD) facilities are one of the most rapidly expanding essential services of the oil field service industry due to the discovery and production of hydrocarbons in shale plays.  These shale plays require massive amounts of water to complete the hydraulic fracturing (fracking) process on the wells. The flowback water must be disposed of once it returns to the surface. In addition, oil and gas wells typically generate significant and increasing amounts of water (produced water) during their production life, which provides a long-term source of revenue potential. A single large horizontal well can generate in excess of 250,000 barrels of flowback after a frac job, and this water must be disposed of at a permitted SWD facility. All water associated with the production of oil and natural gas must be transported to an approved and licensed SWD facility. When no water pipeline system is in place to transport the water, trucks must be used to transport the water to the SWD. Once the saltwater arrives at the SWD, oil is salvaged from the water prior to pumping it into the disposal well. This skim oil can be a significant revenue generator for the facility, well above and beyond revenue associated with saltwater disposal fees. The final step in saltwater disposal is injecting the saltwater into underground formations deep below the surface, sometimes over a mile in depth.
 
Some rough'ish facts / figures related to the attractiveness of the SWD business :
 
SWD's can be thought of as synthetic oil wells, with economics that sometimes are as good or better than actual infield or speculative wells, while being much lower in risk than a conventional well. I am an investor in an SWD that was completed in March. It was drilled to a depth of just over 8,000 feet, and is in a busy area of drilling activity in the Permian. This SWD was $4mm, with $2mm in equity, and the rest bank debt. The operators expectation is that payback will occur in 9-12 months, and that it should generate c.f. for distribution for years to come.The ultimate success of course depends upon volumes delivered to the site, and the skim oil content. I have heard of SWD projects in Eagle Ford that pay back all  invested capital within 6 months, and are expected to return 4-5 times their investment in less than 3 years. Add to this the fact that SWD's are  not nearly as risky as conventional wells. I have been told by our operator that when you drill an SWD, you have an only 1% chance of failure at the well site of drilling a well that will not be approved for disposal. In other words, 99% of SWD's drilled for the purpose of disposal, are successful geologically, and approved for that purpose. Oilfield Water Lines (O.W.L.) which was majority backed by Mark Cuban was bought late last year for $240mm by NGL. At the time O.W.L. had 2 SWD's, generating $40mm in cash flow, and two others permitted and approved, but not yet complete.
 
With numbers and stories like this, there is a lot of money wanting to get into the SWD business. The reality though is that it is early in the game, and CELP is the first public vehicle approved for MLP status with SWD as its primary business. CELP's other line of business is pipline inspection services.  
 
CELP's SWD business presently consists of 2 wells in the Permian, and 7 in the Bakken. The company also has the right of first refusal to co-invest in other opportunities in the Bakken, including an additional managed SWD facility. All of CELP's wells are new generation, all of which having been built since 2011.
 
CELP's pipeline inspection business, though not as sexy, should be a solid line of business. At present in fact, CELP's 50.1% ownership in Tulsa Inspection Reseources (TIR) is the largest generator of revenue at the company. That said, profitability is nearly even between the two components, given the inspection business's 10% margins, versus the 70% margins in SWD's...GP is currently 51% from inspection and 49% from SWD. Further, the 49.9% of TIR that is still held by the sponsor provides for a drop-down opportunity down the road. Pipeline Inspection & Integrity (PII) is a relationship-driven, minimally capital intensive business focused on several key areas including in-line inspection, technical analysis for pipeline integrity (using several methods of inspection), staking services, data integrity and compliance, and construction management. The INGAA estimates that over $250 billion will be invested in North America from 2011 to 2035 for the construction of pipelines and gathering systems. Add to this the aging of the infrastructure, and heightened regulatory environment, and the PII component of CELP should benefit. 
 
In the SWD segment, CELP has a diverse customer base, with 210 customers...The largest 10 making up just over 50% of revenue. CELP also utilizes pipelines to receive the water at 3 facilities, and is focusing on this strategy, which though lower margin (due to higher cost) than trucking the water in, allows for more consistent returns due to the ability to contract for longer periods of time (water trucking in the oilfiled is spot market). Operators are very rigourous in their screening of SWD operators, and this should bode well for CELP as opposed to the mom and pop operators who have traditionally operated in this fragmented market. 
 
For the 9 months ended Sep. 13, CELP's SWD business generated revenue of $17mm, and GP of $11mm. CELP's volumes have increased from approximately 500k bbls in Q3 '11, to 5.2mm bbls in Q3 '13. With curent utilization of only 40%, there is nice upside to current volumes. 
 
CELP should earn around $1.38 per unit in '14, and yield approximately 6.5%, with coverage of nearly 1.17. Not screamingly cheap, but cheap enough given what I belive is a huge opportunity for rolling up SWD's, a new institutionally recognized investment category, with great margins, which is highly fragemented, and which CELP is going at with a pipeline strategy to mitigate the risk of delivery and spot pricing. In fact, the primary risk I see going forward is the current reliance on a spot market for most of their owned SWD's. On a dividend discount valuation, the units should easily reach $26-$27 in '14, with more upside if any of the catalysts below are realized.
 
Finally, I like the management of the company, and met them after being invited to sit in on one of their roadshow presentations. Peter Boylan who is president and co-founder, was a long time senior executive at Libery Media, and sits on the BOD of BOK Financial. I like this fact, as BOK Financial is very involved in the oil patch, and because of his close relationship with George Kaiser of Kaiser-Francis Oil. The rest of the executive team is very impressive, and I would direct you to the company website for further information. Lastly, Charles Stephenson, a member of the BOD of CELP founded Vintage Petroleum (was VIP) which he sold to OXY in 2006. The executive team and board are rich with experience and great connections in the energy industry. For as much sophisticated money there is in oil and gas, it is still very much a relationship / club like business, and CELP is my bet on a way to play the SWD business. 
 
 
 

I do not hold a position of employment, directorship, or consultancy with the issuer.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

 Drop down of the 49.9% of the pipeline inspection business. Acuqisitions in SWD, and an increase in capacity utilization from the current SWD wells.
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