Description

Summary:

There was an excellent writeup done on NOA by Woolly18 in 2014 to which you should refer for more background info. While the stock price has been cut in half since then due to the energy meltdown, the company is performing well and the management team continues to execute above expectations.

 This trade is more appropriate for small funds or personal accounts due to trading volumes.  The company is in a tough, low-quality industry, but the valuation more than reflects this view.

 The current share price is $3.90. Our base case assumptions imply a share price of approximately $6.40 (60-65% upside) by mid-2018 as we see EBITDA grow from depressed levels in 2016 and 2017. This valuation assumes a 4.5x EV/EBITDA multiple, continued share repurchases of 2.5mm shares (from 2q2017, in the 3q2017 they have already bought .5mm shares approximately), and only modest EBITDA growth in 2018.

 Catalysts include a new share buyback authorization and execution in late August or September, a ramp up of new oil sands contracts in Q4 2017, and non-oil sands contract wins.  tuck in acquisitions

 Dividend Yield of approximately 4%  

 2018 FCF Yield over 17%  (assumes no growth capex in 2018)

 The risks include oil sands, energy, and small cap valuations.  Given the small size and volatile energy names this can trade poorly as seen during 2015 and early 2016.

Company Overview:

North American Energy Partners is a provider of heavy construction and mining services, primarily for projects in the oil sands. NOA is run by an excellent CEO with an impressive track record and the company has several catalysts that will drive a realization of the fair value of the company over the next twelve months. They are listed on both the NYSE and TSX.

NOA’s customer base is comprised primarily of investment-grade oil sands energy producers with whom NOA has partnered since they began operations in the oil sands. NOA’s four largest customers are Suncor, Syncrude (a Suncor-controlled JV), ExxonMobil, and Canadian Natural. The past year has seen a recent trend of consolidation among oil sands players with roughly 70% of oil sands assets now owned by Canadian companies. This is a result of deals such as Cenovus’ purchase in March 2017 of US$13.3bn of assets from ConocoPhilips, which included the remaining interest in the oil sands JV the two companies owned. In the same month, Canadian Natural purchased Shell and Marathon’s oil sands assets for a total of US$9.6bn. While previously there were numerous joint ventures between Canadian and international oil companies operating in the oil sands, now oil sands operations are concentrated among the four largest producers.

NOA generates revenue from a combination of operations support services and construction services. Operations support services revenues (91% of net sales) tend to be recurring in nature and are mainly generated under site services contracts while construction services revenues (9% of net sales) are more discretionary.

NOA has a fleet of over 240 pieces of equipment, and has been purchasing more machinery from their distressed competitors, which represents one of the largest fleets of any contract resource services provider in the oil sands. Though oil sands mines have significant upfront costs, operating cash costs sit at approximately US$15-20 a barrel meaning that as long as crude oil remains above US$35-40 and differentials stay in historic range, existing mines remain cashflow positive.

Valuation Summary:

We expect the stock to trade to $6.40 by the middle of 2018 in our base case scenario, which represents upside of approximately 60-65%. 

We expect 2018 EBITDA to grow to US$55mm from 2017 EBITDA of US$48mm. Revenue and EBITDA were artificially depressed in the summer of 2016 due to wildfires around Fort McMurray, which caused stoppages in many of the oil sands projects NOA was servicing. Additionally, NOA like most energy services companies, was forced to make pricing concessions to their customers, which they will not have to make going forward (we are not assuming any pricing benefits either). While we expected Q2 and Q3 of 2017 to show significant year over year improvements in EBITDA due to the quarters affected by fires being lapped, Q2 2017 saw a plant fire that caused a large project NOA had scheduled to be cancelled. NOA won this contract in January and had committed a significant amount of machinery to the project, which they expected to commence in Q2 2017; however, due to the fire, the client cancelled the project, leaving NOA’s assets underutilized. NOA was able to secure other projects for the majority of the committed machinery, but those projects started later than the cancelled project was expected to in Q2. While this means less work this quarter, management guided for “similar recurring earthmoving volumes being available for next winter.” Q3 2017 is still expected to show significant year over year improvement, barring another unexpected natural disaster.

 NOA has been securing their long term revenue streams. The company has extended their master services agreements with their four largest customers to run through 2020.

 NOA has been diversifying their revenues to reduce their exposure to the price of oil. In Q3 2017 they expect 25% of EBITDA to come from their two non-oil field related projects. Over time their goal is to have non-oil sands projects comprise 25-30% of EBITDA, which will help improve the valuation multiples.

 For 2017, NOA has guided for US$25-27mm in maintenance CapEx, and US$12mm in growth CapEx. NOA’s management believes that for every US$10mm in growth CapEx they will realize US$3mm in incremental EBITDA. Unless a significant amount of new awards are won, we do not believe the company needs more growth CapEx in 2018. As a point of reference the company believes they can do US$60-65mm of EBITDA with the assets NOA currently has, including the US$12mm of growth cap ex highlighted above.

 Our base case expectation includes an assumption of US$55mm of EBITDA in 2018, CapEx in-line with management guidance, and 2.5mm shares repurchased (0.5mm shares have been repurchased in Q3 2017 already). Using a trailing 4.5x EV/EBITDA multiple, this implies a price target of $6.40 by the middle of 2018, representing 60-65% upside. This assumes 27mm shares outstanding and US$75mm of net debt. These assumptions do not require a rebound in the price of oil nor any acquisitions, which would represent additional upside.

 Our bear case assumptions include steady EBITDA of US$48mm in 2018 (in spite of management winning significant new project awards) and a trailing 3.5x EV/EBITDA multiple, which imply a $3.40 share price, representing 13% downside (this still assumes 2.5mm share repurchased).   This does not imply a significant decline in oil prices nor any major environmental issues related to the oil sands.

 Management’s Track Record:

CEO Martin Ferron joined NOA in June of 2012 and over the past five years has transformed NOA, but we believe investors are missing this due to the energy market rout of 2014-2016 and the lack of interest in small cap Canadian oil sands players. Since his arrival, Ferron has accomplished the following:

 ·         Expanded operating margins:

o   Operating margins were 9% in FY2011 and have increased to 23% in FY2016. Ferron has significantly improved efficiency and, unlike previous management, only takes on profitable projects.

·         Paid down high cost debt:

o   In 2012, NOA’s debt to EBITDA ratio was over 5.5x. Since, this has been lowered to 1.6x in spite of the recent energy rout and NOA’s cost of debt has been lowered. This has been done by efficient capital allocation and the sale of non-core NOA’s non-core pilings division at 7x EBITDA.

·         Authorized aggressive share repurchases:

o   In contrast to other energy companies, NOA has reduced share count by 18% since 2013 and is expected to continue repurchasing large quantities of shares. Management has also bought treasury stock to limit dilution from share grants to employees.

·         Aggressively acquired shares:

o   Ferron has personally purchased over one million shares in NOA in open market purchases.

 Catalysts:

·         Additional Contract Wins:

o   NOA will have additional projects in 2018 and beyond, including the new Fort Hills mine that is expected to begin ramping up production in Q4 2017. From our research, this should provide C$150mm of revenues for the 3 main oil sands contractors per year. This is a significant driver of EBITDA growth in 2018. NOA is also bidding on non-oil sands projects.

·         Acquisitions:

o   In April of 2017, NOA entered into a joint venture with Dene Sky Site Services, which we expect will add US$2mm to NOA’s 2018 EBITDA. We expect NOA to do other small tuck-in acquisitions, especially in the SAGD support markets. Additionally, NOA recently raised C$40 million in a convertible bond offering with the intention of making an acquisition in the range of C$40-100 million. We believe this has lower odds of occurring, but would be significantly accretive to earnings and cashflow if done correctly.

·         Diversification of Revenues:

o   In the second half of FY 2017, NOA expects 25% of EBITDA to come from non-oil field related projects. Continued diversification significantly mitigates the risks associated with their exposure to the price of crude oil.  This will also help improve valuation.

·         Aggressive Share Repurchases:

o   The company has recently completed a share repurchase program of 1.6 million shares, roughly 5% of shares outstanding, from April 2017 to August 2017. In the near term we anticipate an announcement of an additional 2.5 million share repurchase authorization, which is approximately 10% of the float. Management has historically completed all announced share repurchase authorizations.

·         Lapping Fire-Impacted Quarters:

o   In Q2 2016, there was a major wildfire near Fort McMurray that halted approximately one quarter of Canada’s oil production. This natural disaster impacted NOA significantly, cutting earnings by an estimated USD5-6 million across Q2-Q3 2016. Lapping Q3 will make NOA’s story more compelling to new investors who may be looking at surface level financial information. While Q2 2017 has already passed, it too was effected by an idiosyncratic fire as previously discussed, so Q2 2018 will see the same benefit of lapping a fire-impacted quarter.

Key Risks:

·         Oil Falling Below $40/barrel:

o   While NOA is diversifying away from oil, a sustained decline in oil prices will hurt the company. Though it should be noted the oil sands have low cash operating costs, despite large upfront costs, and production is difficult to stop and restart. At $40+/barrel, oil sands mine should remain operational.

·         Change in Management:

o   CEO Martin Ferron has done exceptionally well at the helm turning NOA around over the past few years and if he were to depart, our outlook for NOA would change

·         Natural disasters and other non-recurring industry risks:

o   Fires in 2016 and now 2017 have negatively impacted NOA’s profitability

Catalyst

share buybacks

ramp of non oil sands projects and new oil sands project coming on line in 2018

oil price stabilizing around 50-55 in 2018