Description

Investment Thesis

McCoy Global is a C$28 million market cap bet on continued strength in energy markets with decent downside protection if energy momentum fizzles. The company’s main product is hydraulic tongs used to secure pipe when drilling oil and gas wells. Though energy prices are well above pre-covid levels, industry drilling activity is muted with global rig count still down about 25% versus early-2020. Energy producers have been more disciplined with their capital to-date, but at some point activity will increase given the attractive returns available at today’s prices and the need for additional supply (marginal cost is about $70 per barrel of oil). McCoy’s revenue will benefit from an uptick in drilling activity and, according to management, margins should outperform previous cycles because of restructuring during covid (McCoy cut headcount by 25%) and the 2017 closure of its Edmonton manufacturing facility.

Specifically, in a “modest” recovery scenario where revenue returns to the roughly $50 million range seen in 2018 and 2019 (versus $33 million in 2021), the company could generate $7-$8 million of EBITDA based on management guidance for 15-17% adjusted EBITDA margins at $50-$60 million of sales. This puts the stock at about 3x EBITDA and a FCF yield in excess of 20% given low capital intensity. A resurgence of activity to levels seen in 2013 and 2014 could drive revenue above $100 million and EBITDA to $15 million or more, putting the stock at 1-2x peak EBITDA.

Should the recovery in drilling activity fail to materialize, the downside at McCoy is well protected by C$1.03 per share of tangible book value and C$0.79 per share of net working capital as compared with the current C$0.95 share price. The company should also be operating at roughly break-even free cash flow even at the current depressed levels of industry activity, protecting the balance sheet.

The risk/reward on McCoy appears compelling with upside of 100% in a modest recovery scenario that appears likely to transpire over the next few years given current energy prices against downside of 20% to net working capital if the recovery fails to materialize. The presence of Alex Ryzhikov on the Board, a former employee of McCoy’s two largest shareholders – Burgundy and Ewing Morris – also provides comfort that shareholder value will be prioritized.  

Details on McCoy’s Business

McCoy sells various tools to case and run pipe on oil and gas drilling rigs. McCoy’s main product is hydraulic tongs which are used to connect (“thread”) pipe by applying torque to join one piece of pipe with the next. McCoy also sells a casing running tool (“CRT”) which is a more sophisticated alternative to hydraulic tongs capable of placing the pipe in the correct position on the rig floor without manual intervention. The hydraulic tongs can sell for $150-$200k while the CRT could be up to $500k. McCoy acquired the CRT with the DrawWorks acquisition in 2018. Management estimates its market share for hydraulic tongs is 40%.

In addition to the upfront original equipment purchase, McCoy sells recurring aftermarket parts and services for the hydraulic tongs. According to a former McCoy employee I spoke with, “the power tong is a highly abused tool with a lot of highly abused parts. It needs to be rebuilt frequently”. The dye inserts which grip the pipe might need to be replaced every two hours. Management estimates that 40-50% of 2021 revenue of $33 million was from aftermarket.

McCoy mainly sells its products to service companies like Baker-Hughes. The product is relatively undifferentiated, though, according to the former McCoy employee I spoke with, the company does have a good reputation because they have been in the market for a long time and are known for the depth of their product assortment. McCoy can also differentiate itself on challenging projects with tight specifications. For example, McCoy tends to do better in the offshore vs. land market or for small diameter, high torque projects. 

Competitors include service companies like Frank’s and Weatherford that produce their own in-house tools as well as pure tooling companies like NOV, Forum, and Eckel. According to an executive at a tubular running company that I spoke to, NOV was the original innovator in the hydraulic tong space but has lost share over time on price and poor service. Even though Frank’s and Weatherford have their own in-house product, they would also be customers of McCoy because McCoy has a more extensive product assortment. McCoy management believes they have a stronger competitive position outside of North America where customers care more about procuring the complete package from one supplier (ie. original equipment + aftermarket parts + service, not just the tool).

McCoy manufactured its equipment in-house at its Edmonton facility until 2017 when it outsourced production to a third-party manufacturer. McCoy does continue to produce some aftermarket parts in-house at a couple facilities in the US. The volumes on these parts tend to be so consistent that there is less risk of operating de-leverage during a sales downturn. Since most manufacturing is outsourced by McCoy, the business is capital light. Capex was $3-$4 million per year over the past few years, but roughly half of this has been spend on technology initiatives which will be winding down over the next few quarters.

McCoy’s technology initiatives update the equipment to include sensors and more automation. This allows for less labour-intensive operation of the equipment and for more information on the quality of the pipe connections. Over the next couple quarters, McCoy will have proved out the functionality of the new products in a live setting and will ramp-up commercialization efforts. I do not expect technology to be a major driver of revenue for McCoy in the near-term, though a tight labour market could contribute to incremental interest from customers.

Review of Historic and Prospective Financial Performance

McCoy’s revenue and profitability have been challenged since the end of the last energy cycle in 2014. As you can see in the graph below from McCoy’s filings, global rig count was down by 30-50% in 2020 and 2021 as compared to pre-covid levels and is down by 50-60% versus 2013 and 2014.

McCoy’s revenue exceeded $100 million in 2013 and 2014 during the peak of the last cycle, but since then has bumped along in the $30-$50 million range. Over the past four years and even through the covid weakness, adjusted EBITDA margins have been climbing higher from roughly zero in 2018 to 10.5% in 2021. The closure of the Edmonton facility in 2017 and the elimination of 25% of the workforce during covid (which management says is a sustainable reduction) have boosted margins along with a favourable mix shift towards aftermarket. Margin strength continued in Q1 2022 with adjusted EBITDA margins of 16.4% up from 9.1% in the prior year as revenue increased from $7.4 million to $8.9 million. Recent strength has come mainly from aftermarket as idled equipment is brought back into service.

Looking ahead, I expect global rig count will trend higher on the back of attractive well returns at current (or lower) energy prices. McCoy management believes it can deliver EBITDA margins in the 15-17% area with revenue of $50-$60 million, putting EBITDA in the $7-$8 million range in my modest recovery scenario. I think the stock would trade to at least 6x EBITDA/10% FCF yield in this scenario which would drive upside to C$1.85 or 85%.

A Final Note on McCoy’s Shareholder Base and Board

McCoy is a tightly held stock with a high-quality shareholder base. The two largest shareholders are prominent Toronto value shops Burgundy and Ewing Morris that own about 30% combined. Cannell Capital and Fidelity own another 23% combined and CEO Jim Rakievich owns 2.6%. Alex Ryzhikov, formerly of both Burgundy and Ewing Morris, was appointed to McCoy’s Board in mid-2021 to lead a special committee reviewing strategic alternatives. The work of the special committee concluded recently without a sale of the company which management attributed to a wide bid-ask between shareholders and strategic buyers. Specifically, shareholders did not want to give the company away as it is trading around liquidation value while being public may have hampered the process as buyers are reluctant to pay a huge (eg. 100%) premium to the current share price. With the work of the special committee concluded for now, the Board plans to implement a normal course issuer bid in the near-term.

Catalyst

Increase in drilling activity

NCIB activity