Description

Natco is an oilservice company that manufactures equipment used in the production of hydrocarbons. The company focuses primarily on well separation equipment, instrumentation and electrical components for monitoring the production of oil and gas, and engineered systems for larger hydrocarbon projects. The company’s primary business is leveraged to the rise in the rig count, which has been rising strongly with the recovery in oil and gas prices over the past two years. Despite the Natco’s tremendous leverage to the recovery in oil and gas drilling, the company trades at a steep discount to the rest of the mid/small cap oil service companies. For example Natco is trading at 6.5x and 4.9x estimated ’01 and ’02 EBITDA, respectively versus industry averages of 10x and 7.5x, respectively. Meanwhile earnings and EBITDA should grow by 36% and 33% this year, respectively. Natco has been a public company for just over one year, and is still in the “penalty box” for missing earnings in the third quarter last year due to delays in project awards in its engineered systems segment, which was an issue with the industry as a whole. On the fourth quarter conference call, management emphasized that bidding activity in the industry is now the highest they have ever seen, and if the company maintains its traditional win rate on projects, we will see a significant build in backlog on the heels of the growth they already exhibited in the fourth quarter. As the “Street” gets comfortable with the recovery in the engineered systems segment, the multiple differential to its peers should close dramatically. Additionally, with only $6 million of annual capex, and EBITDA approaching $30 million, Natco should generate strong free cash flow. Meanwhile, the company is in the process of closing on a UK acquisition, which will be immediately accretive to earnings, and in the past six months, management have been big buyers of the stock for their personal accounts to the tune of over 600,000 shares, on top of their already significant ownership. The risk to the story is obviously commodity prices, but with a strong balance sheet, and its cheap valuation, Natco is a greatly overlooked stock in an industry that has been well picked over in the past year. Natco should trade at least in line with industry multiples, which equates to a target price of over $17, or 55% returns from today’s levels.

Catalyst

1) New awards in the engineered systems segment, which should be forthcoming in the next two months 2) Rotation into later cycle energy plays as the early cycle plays have moved dramatically 3) continued rise in the rig counts as exploration and production company budgets continue to rise at double digit rates in 2001 4) Acquisition candidate; Natco would be attractive to Varco, Smith International or National Oilwell