Description

McCoy Global (MCB CN) is a relatively cheap and safe way to play any recovery in drilling activity that happens over the next several years.  It has a cash rich balance sheet and should run at break-even levels for 2017 if sales don’t increase materially from here, purchasing at $2.00, below tangible book value, a margin of safety to see out a slow recovery.  They have a market leading position in their product category, which is applicable to every well drilled.  The company has made an opportunistic acquisition at the downturn that has the potential to be a home run.  Insiders have been adding to their holdings recently at current prices, which is also a good sign.

Background – The core product of the company is hydraulic tongs.  A worker uses this tool to grip a pipe at the wellhead and apply torque to the pipe to spin it around and connect threaded pipes.  The alternative is a person using a hand tool.  This is a safer and faster approach.  Any time pipe is being put down a well, a hydraulic tong will be present.  The company sells dies that are the metal pieces that comes in physical contact with the pipe, which wears out and drives some aftermarket revenue.  The product is present onshore and offshore for any oil or gas well.

Investment framing – McCoy has a stellar balance sheet and an income statement leveraged to a recovery in drilling activity.  With approximately 28m shares outstanding and a $2 share price, the market cap is about $56m.  Proforma for a recent acquisition, they have roughly $14m in net cash on the balance sheet, so the EV is about $42m.  They exited Q4 2016 with an approximate $6m/yr cash burn rate.  Their goal for 2017 is to reach positive EBITDA, with $40m in revenue being about what they need for break even, and their proforma revenue is $36m.  I estimate their midcycle revenue is about $85m with a 10% EBIT margin, so the company trades for 5x midcycle EBIT.  My long term high case would be a return to prior proforma peak for acquisition with $150m in revenue with a 15% EBIT margin, which puts it at less than 2x peak EBIT.  Even with a tepid recovery where the company gets back to about $60m in revenue with an 8% EBIT margin, it still trades for under 9x EBIT.  Fully taxed, that comes out to 12x earnings with a very conservative assumption for the oil and gas drilling backdrop, with tremendous optionality on any recovery.  At first blush, this appears an average opportunity, but the very valuable options are ascribed little to no value and the balance sheet strength gives them a long duration.

The Earnings Cycle - 2016 revenue of $27m doesn’t represent any runrate level of revenue where there is any drilling activity going on.  Neither does their -17m of EBITDA, with a slew of write downs, restructuring, and cost mismatch to the environment.  The drop in revenue is a function of decreased activity as well as customers utilizing existing equipment and cannibalizing it for any parts for repairs.  Back in 2014, aftermarket revenue was about $50m of the $120m total, which would consist of repair, spare parts, and consumables.  In 2009 and 2010, revenue was about $66m and $68m, respectively.  While different conditions existed at the time, it is a decent proxy for thinking about the business with slower activity, but not having as much excess inventory on customer’s balance sheets that they could absorb.  With 3PS and the legacy business returning to half their prior peaks would imply $75m of revenue for the legacy business and $13m for 3PS, which is $88m, so my midcycle numbers aren’t incorporating a return to 2012-2014 activity levels.  Even with the minor resurgence in drilling activity, some companies will need to invest in more capital equipment and all companies will probably have to spend a little money refurbishing existing equipment.  The company has the balance sheet to wait for the market to fully return even if this current increase proves fleeting.

Smart acquisition – Besides the relatively cheap valuation, strong market position, and fortress balance sheet, probably the most underlooked aspect of the investment case for McCoy is their January 2017 acquisition of 3PS for $8m.  They paid about 1x depressed revenue for a business that the seller purchased for $25m 5 years ago when it was generating about $25m in revenue from torque sensors, half to the onshore O&G industry and the other half to cranes and offshore platforms.  This business likely has higher margins than the historical average of McCoy, but is currently breakeven.  The core product is sensor packages that monitor real time torque, both in the drill pipe as well as the mooring systems and crane cabling for offshore and crane industry.  This enhances the existing hydraulic tong offering in a way that will further differentiate McCoy from its competitors and help it deepen relationships with customers.

3PS has relationships with the same customers that McCoy targets in North America, which should provide nice cross selling opportunities to penetrate accounts further.  3PS has no overseas presence, but will not be able to use McCoy’s overseas footprint to attract more business.  3PS brings leading technology, as several years ago their crane and offshore monitoring business was $8-10m of revenue, but they never had any sales or development resources devoted to this, so customers were actually seeking them out.

McCoy already had some offering around this product segment, but 3PS brings much more depth and expertise.  Furthermore, McCoy was in the position of having to invest in a larger facility to perform maintenance and calibration of torque sensors, but got the facility and equipment to do so with the 3PS acquisition (both companies provide this).  This both improves the company’s aftermarket opportunities and leverages fixed costs. 

Competition - McCoy has roughly a 40%+ market share globally, tending to focus on offering more variants with a range of size and power characteristics compared to competitors.  They have also invested more money in sensors and software to help improve the accuracy, performance, and information provided by the product.  The other competitors include Eckel (a TX-based family firm), Weatherford, Franks, and NOV. 

While NOV is a larger company, they don’t have a wide offering.  NOV’s most powerful power tubing tong has a max torque of 20,000 ft-lbs that can handle tubing up to 10-3/4” compared to McCoy’s 75,000 ft-lbs and tubing up to 15” in size.  In most situations NOV might be expected to have the upper hand, but McCoy has a deeper product catalog of the tongs in addition to further analytic tools focused on this specific part of the drilling value chain.  It would be a sensible tuck in at some point for NOV to just acquire McCoy to be able to offer a wider product range.

Franks only produces tongs for internal use.  Weatherford produces tongs internally as well, but has underinvested in the product line for years.  As a result, McCoy actually supplies Weatherford with larger models in most geographies and even supplies the entire range for Weatherford in places like LatAm.

Eckel is family held and has a wide line-up similar to McCoy.  They have invested less over the years in a more advanced technology offering.  Eckel has not gone overseas.  This could be interpreted as customers preferring to partner with McCoy when considering suppliers they want to bring overseas.  McCoy has their own offices in Singapore, UAE, and the North Sea.

Customers – The company works with a range of service companies, from Halliburton to Baker Hughes to Weatherford to smaller players.  The top 10 customers are about ~50% of revenue, with the top 20 comprising ~75%.  The top 10 move around a lot because of chunky orders, but the top 20 are the usual cast of characters.

Inside ownership – Management has a variety of positive incentives for the business and the share price to be materially higher in coming years.  First the CEO owns 1.85% of the company, worth about $1m.  He has made several open market purchases in early January after the announcement of an acquisition, increasing his stake, as have other insiders.  The options grants in 2016 is at current share price levels, but 2/3 of the options required much higher prices. 

Catalyst – Over the year, the company should provide further details on the 3PS acquisition as well as see customers return for aftermarket support, if not a few orders of equipment.  If oil activity resumes in the next 3-5 years, McCoy stands well positioned to benefit.

Important Disclaimer:  This report does not constitute a recommendation to buy or sell the security discussed herein.  The report is an example of the author’s company write-ups / research process; its breadth and coverage may differ materially from other such reports.  Certain statements reflect the opinions of the author as of the date written, are forward-looking and/or based on current expectations, projections, and/or information currently available.  The author cannot assure future results and disclaims any obligation to update or alter any statistical data and/or references thereto, as well as any forward-looking statements, whether as a result of new information, future events, or otherwise. Such statements/information may not be accurate over the long-term.  The views are those of the author acting in his individual capacity and not as a representative of any other person or firm; in no way does this report constitute investment advice on behalf of any other such person or firm.

Catalyst

Recovery in oil