Description

Enservco

Enservco is a rapidly growing service provider to the onshore domestic oil and gas industry that we believe is trading at less than half of what we peg as intrinsic value.  We believe that at current prices, one is buying the core business for fair value and getting its substantial growth for free. Having come off the pink sheets in March to a listing on the NYSE, it is largely unknown to the investment community and we expect it will appreciate significantly and quickly once discovered.  In short, we think Enservco represents an opportunity to double your money in the next 12-24 months through multiple imminent catalysts and low risk of permanent loss.

Business Summary

Much like seismic exploration companies provide large and independent energy companies with services that help them prospect for drilling sites, Enservco helps these companies in both the drilling and maintaining of their wells. Their services both extend the drilling season in colder climates and extend the life of its customer’s wells.  What is particularly attractive about their business is that they are crucial in facilitating successful exploration and production, while representing a tiny cost relative to total drilling expenditures.  In the context of multi-billion dollar drilling programs, this is an enormous value-add where reliability and staying power of the provider are extremely important.  For this reason, customers tend to be sticky as they focus less on cost and more on execution and reliability.  Moreover, Enservco is the only national provider of these services, a major selling point to large energy companies operating in multiple geographies as well as a significant barrier to would-be competitors.

We suggest you look at the company’sInvestor Presentation, and we’ll also provide a brief summary of the business.  

They have 4 primary services divided into two divisions:

1.       Well Enhancement Services

a.       Frac Water Heating - Frac water heating is the process of heating water used to frac oil and natural gas wells.  The process prevents water from freezing prior to entering the well bore and ensures frac solutions are warm enough to blend properly.  In plain English, they provide on-site water boiling services to drillers with their 34 specialized trucks.  This service extends the heating season in many basins.

b.      Hot Oiling - Hot oiling involves heating and circulating oil or similar fluids down a well bore, where the fluid dissolves and dislodges paraffin and other hydrocarbon deposits.  Hot oiling is also used to heat the contents of oil storage tanks, a process that eliminates water and other soluble waste that can reduce the operator’s revenue at the refinery.  In plain English, they periodically clean out wells to increase production and reduce contaminants with their 27 specialized trucks.  For Enservco, it represents a recurring, maintenance-related service that is performed throughout the life of a well.

c.       Acidizing - Acidizing involves pumping specially formulated acids and/or chemicals into a well to dissolve materials blocking the flow of the oil or natural gas.  It is used for increasing permeability throughout the formation, cleaning formation damage near the wellbore and removing the buildup of materials restricting the flow in the formation.  In plain English, this is similar to hot oiling, but done with an acid cleanse with their 3 specialized trucks.  It is also a recurring, maintenance-related service that is performed throughout the life of a well.

2.       Fluid Services - The fluid management business transports water to fill frac tanks or reservoirs at well locations, transports contaminated production water to disposal wells, moves drilling and completion fluids to and from well locations, and transports flow-back fluids from the well site to disposal wells.  In plain English, they haul clean water to a drilling site and take dirty water to an approved disposal site with their 65 specialized trucks.  These services are utilized during both the drilling and long-term maintenance of a well.

The Business Model and Opportunity 

Their core business model is to support their partners in new drilling with the Fluid Services, then generate recurring maintenance revenues over the life of the well from the Well Enhancement Services.

We believe historical numbers demonstrate that the company has incredible leverage on SG&A and its customers are happy about the service they have received.  New revenue is largely linked to new drilling, and as such, the company has indirect exposure to energy prices.  In addition, the largest areas of growth are coming from hot water fracking, which is highly seasonal with the majority of revenues coming in the colder months.  The company has been running beyond capacity and has been bringing on new capital equipment to meet customer demand.  They have been able to do so using largely retained earnings and a small bank line.  We believe this is going to lead to tremendous revenue growth over the next few years as they are able to deploy the new equipment to generate revenue while keeping their SG&A low.  

Another growth opportunity for the company is expanding into new geographies, a process which has already begun.  As the company follows its customers into new geographies, we are seeing a mitigation in the mix of revenues and the seasonality of the business. 

Management

Current management has shown themselves to be astute operators, both from an operational and financial perspective.  They have real skin in the game, owning over 45% of the company and participated in the company’s capital-raising efforts as recently as 2012.  We believe the significant inside ownership will lead to a pursuit of prudent growth.  PNC, the company’s current lender, also seem to be watching things closely as they are required to approve all capital spending budgets.  This provides us an additional layer of comfort.

Undiscovered

We are kicking ourselves for not having found the company earlier when it was trading below $1/share, but a recent S-3 filing spooked the market and we were able to buy shares around $1.80.  The S-3 is a non-event and was required to replace and expiring shelf registration that covered a private placement from 2012.  

Until this past March, the company was traded on the OTC markets with an already thin float.  In March, as the company organically traded above $2/share, it gained an NYSE up-listing which has brought more liquidity into the name.  As institutions begin to learn the story and the company receives sell-side coverage, we believe the stock will re-price higher very quickly.

On March 13th, they will report Q1 numbers which we believe they will blow out of the water as they have already pre-announced excellent January numbers.  In addition, margin from December 2013 were depressed in their hot water fracking segment due to high propane prices.  Q1 margins should be substantially better as price triggers kicked in and the company is passing through propane costs on to customers.

In May, concurrent with earnings, we expect the company will also publish its new capital budget for 2014/2015.  This will allow the market to impute forward revenues and we expect it will be aggressive given growing demand from its customers.  This, along with affirmation from the company that it will not be issuing new equity, should be another catalyst for the stock to re-rate upwards.

From the last earnings release:

“We started 2014 with considerable momentum, as January and February represented the two strongest revenue months in Company history,"

Competition

Most competition comes from local providers that vary by service and geography.  Enservco is the remains the only national provider in all their given verticals.

Valuation

Our calculation of Enterprise Value is shown below:

In our valuation analysis, we looked at three different scenarios.  Our standard practice is to look at valuations on a three-year forward basis and the calculations below are our projections for Enservco’s stock price at the end of 2016.

Note we use pre-tax FCF multiples.

Low:  In the low case, we assumed the company’s growth stalls and there is no improvement in margins.  Essentially, this would be the value if the company continues to produce at 2012 levels.

Base:  The base case, one which we think is 80% likely, the company continues its impressive growth and margins improve with scale. We think and 8-10 pre-tax multiple is appropriate for the a company with this growth profile.

High:  The high case is one which we think is unlikely as well, but implies accelerated growth and dramatic improvement of margins. Possible but not probable.

Summary

We believe that Enservco is an under-the-radar company that provides an essential service with high attachment rates to its customers.  Its costs are modest relative to the billions of dollars in drilling expenditures and it has reached its operational inflection point where we should see continued growth in its FCF as it moves into new geographies with its customers.

At current valuations, we believe you are buying the base business for close to fair value and getting the tremendous growth and operating leverage for free.  Over time, those two options should prove extremely valuable.

- Customer Concentration

- Weather/Seasonality

- Anti-Fracking initiatives

- Equity Issuance

Catalyst

• NYSE uplisting taking hold
• Sell-Side Coverage increases
• Institutional ownership as they do IR presentation
• May 2014 Cap-Ex budget announced
• May Q 1 earnings beat