Description

Note: All values in CAD unless otherwise noted.

Summary

My current trade idea is a small, but well-managed operator, in a profoundly unsexy business, that I believe offers investors asymmetric upside. The investment concerns here are many: exposure to high-cost Canadian oil & gas producers during an energy bear market, significant customer concentration, horrendous revenue trends (-53% in 2016), recent earnings deficits—to name a few. 

So why even bother taking a closer look? 

I believe that Macro Enterprises’ liquidation value and free cash flow profile support fairly limited downside with multi-bagger upside over the course of a full commodity cycle. This is not to say that Macro is a full-blown liquidation play. Conversely, I am not positing that business is poised for an immediate return to its historical peaks. Rather, I believe this is a name for individual investors to gradually and opportunistically accumulate shares in. Skimpy trading liquidity in this name offers the occasional opportunity to add small incremental positions at attractive levels. 

Something of a mixed blessing for MCR as a new trade idea, the company recently announced a significant MOU with Kinder Morgan that drove the EV meaingfully upward. Consequently, I had to update the market levels in my write-up. While this affirms the notion that things can't get much worse before they get better, and rerates the stock from the cheap/downtrend quadrant to much more exciting cheap/uptrend quadrant, it does somewhat diminish the liquidation prong of my thesis.

With a market cap of $55mm (now $77mm – see "Competitive Dynamics" section), balance sheet cash of $28mm, and debt of $1.5mm, the enterprise value sits at $29mm (now $51mm). Non-cash working capital represents another $15mm of assets that can be monetized with relative ease during a liquidation scenario. The balance sheet also benefits from a sizable fleet of equipment and machinery, which the management team believes to be worth ~$80mm (FMV). This estimate, called out in Macro’s investor materials, is based on a 3rd party valuation from circa 2015, but management remains comfortable with that figure based on relatively light utilization, continued M&R, and incremental fleet capex subsequent to the appraisal.

While we should obviously be leery of relying on book value, Macro’s balance sheet gives us some limited evidence that this company trades at a discount, but I will explore liquidation value further below.

Company Overview

Founded in 1994 and headquartered in British Columbia, Macro Enterprises (MCR.V) is an infrastructure services company serving the oil & gas industry throughout Western Canada. British Columbia and Alberta represent ~80-90% of Macro’s business, with some additional work done in Saskatchewan and Manitoba. 

The company’s primary service offerings include pipeline construction, facility construction, and maintenance:
- Pipeline Construction involves surveying the land, clearing and grading the right of way, excavating the trench using backhoes or trenching machines, bending and arranging the pipe joints, welding the joints together, lowering the pipe, backfilling the trenches with topsoil, testing the line, and restoring the land to its original condition. The process can take well over a year, and can get increasingly more challenging in harsh terrain. Pipeline projects have ranged from 2” to 60” in diameter, essentially covering the full spectrum.
- Facilities Construction follows a similar, though less uniform, process, that typically starts with clearing and grading and excavation, but often requires foundational and structural work, in addition to the installation of mechanical and electrical systems (e.g. compression, pumping, and process equipment).
- Pipeline Repair and Maintenance generally involves the excavation, assessment, and refurbishment/repair of sections of pipeline, and can be part of a planned maintenance program or of one-off emergency work. Much of Macro’s maintenance business comes in the form of maintenance and integrity work contracted through 3 MSAs with large blue-chip companies based in Canada, with infrastructure that stretches all of Western Canada and into the United States. Notably, a portion of the MSA revenue is driven by non-discretionary work regulated by Canada’s National Energy Board.

Outlook

Macro’s business is heavily tied to the Canadian energy industry. Specifically, while maintenance services are generally non-discretionary and more resilient to downturns, the company’s construction revenues are entirely dependent on capital investment by energy producers and correlated with local rig counts. 

For industrial service names, I tend to focus less on commodity prices and more on second order industrial measures. According to StatCan, the y/y trend inflected negatively in 1Q15 (-21.3% y/y), bottomed in 4Q15 (-48.4% y/y), and inflected positively in 1Q17 (+2.2% y/y), with 2Q17 (+14.9% y/y) marking the first double-digit gain in almost 3 years. Similarly, Baker Hughes rig counts in Alberta and British Columbia, while nowhere near recent peaks, are demonstrating sufficiently encouraging momentum to say that the end market appears to be stabilizing with potential for an upswing on the horizon.

For the rest of the year and into 2018, the region is beginning to see an uptick in construction projects and is expecting to see a volume of announced work not seen in several years. With the completion of Enbridge’s merger with Spectra, one of Macro’s top clients, the company is likely exploring potential projects in its combined footprint. 

Near-term, 3Q17 revenues should clear the YTD total of $38mm owing to seasonality and an improving demand environment. Illustratively, a $45mm top line result would represent a 127% y/y improvement and depending on mix could yield a high single-digit $mm EBITDA print (vs breakeven in prior year quarter), which would be the best quarterly result in years.

Competitive Dynamics

Macro competes primarily with local specialty contractors, including Surerus Pipeline, Ledcor, O.J. Pipelines, Waschuk, Banister Pipelines, Robert B. Somerville, Michels Canada. None of these names are publicly traded. More diversified Engineering and Construction with divisions that compete with Macro include AECOM, Aecon Group, Wilbros, and MasTec.

Macro’s customer base comprises large energy producers including Shell, Encana, Nexen, Williams, Encana, and Cenovus, as well as pipeline operators including Enbridge, Pembina, and TransCanada. During this low-capex environment, revenues have been quite concentrated, and 85% of the company’s 2016 sales were derived from two customers.

Most recently, and responsible for driving the recent upward move in share price, Macro announced in September 2017 that it has entered into a memorandum of understanding with Kinder Morgan in connection with the construction of 85 km of pipeline along in British Columbia. Bidding windows tend to be fairly short, generally with no more than a 90-day outlook, so it is unclear if Macro has any other active pursuits in its pipeline. Clearly, management’s ambition has been to anchor its backlog with larger and longer-term projects, particularly in the wake of LNG project delays. Each announced win will invariably drive up the valuation, but will give us incrementally more comfort in our turnaround thesis.

Contract Terms

Macro largely relies on fixed price contracts for its lower-risk facilities work, but management has noted a preference for cost-plus projects in signing project work, especially in more challenging environments. Predictably, much of today’s MSA work is done on a fixed price basis. 

Although the company doesn’t regularly break out its revenue by maintenance vs project work, when I asked the management team, they estimated that higher-margin project work has eroded from ~50% of annual top line to ~20%.

PP&E

As with all deep value falling knives, we want to get some sense of our downside protection. In Macro’s case, the company’s enterprise value is cushioned by a large fleet of equipment, which is detailed by cat class in the annual report. Based on a book value of $44mm, Macro’s property, plant, and equipment roughly covers the firm’s $51mm enterprise value. 

This book value of PP&E is far below management’s $80mm estimate of FMV. However, we have some evidence that management has accelerated its depreciation of equipment, as the company consistently books gains on its fleet disposals.

This is not to say that we should assume the company would be able to realize the full $80mm in FMV in the case of an orderly liquidation, but we can take some comfort that the fleet may be undervalued as it stands. Additionally, the company owns 20 acres of prime industrial space in Fort St. John, BC that has appreciated considerably in 2 decades of ownership. Based on a cursory look at comparable industrial sites, we might assign a value of ~$10mm to this facility.

But the thesis here is driven less by orderly liquidation value, and more by the notion that we have reasonable real asset value, sufficient cash flow, and liquidity to ride out a protracted period of anemic oil & gas activity, and massive upside in the case of a significant rebound.

Ownership

Founder and CEO, Frank Miles, owns approximately 33% of the company. Insider transactions have been sparse, with no insider sales or purchases recorded since energy prices began to collapse in late 2014. Based on my discussions with management, a large asset sale or sale of the whole company, while not imminent, is a possibility. The company appears to be open to the dialogue and we note that MasTec, which owns a robust oil & gas backlog, has acquired a number of regional pipeline contractors in recent years, while AECOM remains active on the acquisition front. Granted, MasTec’s previous foray into Canadian energy services resulted in a sizable goodwill impairment that could preclude any further interest in the region.

Liquidity

Macro’s liquidity position is nominally ample given its limited near-term capital requirements and free cash flow profile. The company has an undrawn $65mm 3-year revolving credit facility and a $50mm secured letter of credit facility; however, the company amended its credit agreement earlier in the year after tripping its minimum equity covenant, with the resolution requiring a temporary reduction in commitment to $15mm. Beyond the undrawn revolver, Macro has $1.5mm of equipment financing debt, ~$900mm of which is current. Management estimates that the company requires ~$25mm in working capital for every $100mm of revenue. As a result, we would expect FCF growth to be modestly impacted by WC accumulation in an upside scenario.

Trading Multiples

Years of experience modeling squirrely industrial services businesses have taught me that doing so for commodity-focused operators can be a maximum pain generator. Relying on future curves or economic indicators for out-year or even near-term projections is not particularly advisable in this case either. I have had more success by widening my scope and looking at a range of historical and potential scenarios. 

Annual sales peaked in FY2013 at $212mm. Trailing EV/Sales has ranged from 0.1x to 0.9x. Although pure-play trading comps are somewhat limited, I used AECOM, Aecon, MasTec, and Willbros in my analysis. These first trade at a trailing EV/LTM Sales of 0.5x, 0.5x, 0.8, and 0.3x, for a median of 0.5x, and min/max of 0.3x/0.8x. A rebound to $150mm with a 0.5x multiple – roughly the midpoint between LTM and historical peak and a 0.2x contraction in price-to-sales – would get us to an enterprise value of $75mm. A return to $210mm in sales with a further 0.2x multiple expansion would get us to a $189mm enterprise value.

Annual EBITDA peaked in FY2013 at $48mm. EV/EBITDA is more nuanced, with all of AECOM, Aecon, and MasTec in the 10-11x range LTM with Willbros owning negative multiple. On a 5-year trailing basis, the range widens to 7.5-9.7x (Willbros still “nm”). Recent transaction comps include Pacer/MasTec (5.5x enterprise multiple), Big Country/MasTec (5.0x), Precision Pipeline/MasTec (3.4x), Flint Energy/URS (11.2x), DBM Global/Harbinger (5.8x), CBI/Praxair (6.8x). Since EBITDA has bounced around breakeven in recent periods, I used a wide illustrative range of 1.0-9.0x to capture virtually all of the conceivable steady-state multiples. Then, based on the private transaction ranges, I consolidated that range around the 3.0-5.0x columns. A rebound to $30mm in LTM EBITDA with a 3.0x multiple – a directionally positive but not egregiously upbeat scenario – would get us to a $90mm enterprise value. A less likely but not inconceivable return to $50mm in LTM EBITDA with multiple expansion to 5.0x would get us to a $250mm enterprise value.

Investment Strengths
- Intrinsic value of the underlying assets represent a reasonable cushion to the downside case; equity value is ~9% below the book value of the company’s PP&E and net working capital, and I believe that the company’s fleet and headquarters are worth appreciably more than book value
- Annual free cash flow has been sufficiently positive during the historically challenging period since 2014 to support capital requirements and allow for modest deleveraging
- Committed liquidity is ample, albeit temporarily constrained by a recent credit agreement amendment
- Recently announced MOU with Kinder Morgan supports the view that project work in in the early stages of inflection, or has at least bottomed out

Investment Weaknesses
- Challenging oil & gas environment, with limited visibility around potential project work; while the recently announced MOU with Kinder Morgan is the first such green shoot in several periods, a return to FY2013 or even FY2015 levels of project work could take multiple years
- Potential for further dilution
- Poor trading liquidity 
- Canadian equity markets are among the most fully valued in the developed world by several measures including trailing P/E and CAPE

Catalyst

- Announcement of a major pipeline project contract win
- Prolonged rebound in energy prices 
- Improved sentiment around Canadian LNG export 
- Acquisition by a strategic bidder or an announced joint venture with a blue chip operator