Description

ProFire Energy (Nasdaq: PFIE) is a microcap oilfield technology company, specializing in the design of burner-management systems and other combustion-management technologies. ProFire is the market leader in a niche industry (80% share according to management), generates strong FCF, and has a pristine balance sheet which will enable it to sustain potential declines in oil prices, and offers significant upside with stable / increasing oil. Generating ~$8mm in normalized EBIT on $43mm in Enterprise Value ($66mm market cap, $23mm cash and liquid investments) for a ~5.4x multiple. This has historically translated to ~6mm in annual FCF generation for nearly a 15% yield. With opportunities for both organic growth through R&D and bolt-on acquisitions, ProFire has significant long-term upside for those willing to weather the short term risks. 

Company Background

ProFire was founded in 2002 in Alberta, Canada and became public in 2008. ProFire was at that time a Canadian only company with $3.5mm in revenues, and today does ~$45mm revenue. Revenues grew from $15mm in 2013 to $33mm in 2014 (EBIT $2mm to $8mm), driven by significant expansion investments in the US and the release of new product lines. ProFire then grew to $50mm in 2015 before the brutal oil downturn, cutting revenue to $27mm in 2016. Despite the massive revenue drawdown, the company managed to be about EBIT breakeven and operating cash flow positive. One of the reasons they were able to generate positive FCF is that ProFire doesn’t actually manufacture the products; they outsource the production to third-parties, meaning they have pretty low CapEx and benefit from a fairly asset light model.

Insider ownership is relatively high, with co-founder Brenton Hatch still owning ~9 million shares, or ~19% of the 48 million shares outstanding. 

Value Proposition / Product Overview 

ProFire offers a high margin, high ROI product mainly to North American oilfield services companies.  The production and transportation of oil & natural gas requires various vessels which all require a burner flame to function properly; this is where ProFire provides value to their customers. The majority of the industry uses antiquated manual reignition. When a flame goes out, an employee would need to reignite the flame manually, using a fuel-soaked rag and stick and waiting for the gas to catch fire. Obviously, this presents safety hazards and ProFire has still been able to grow its penetration in the market as operators look for safer and more reliable technology solutions.

ProFire’s burner management systems (“BMS”) ignites and re-ignites the burner flame, and can do so automatically, saving precious production time. It also monitors and manages the temperature of the vessel, providing important safety benefits. The BMS can be monitored remotely as well, meaning the vessel does not need to be constantly checked for reignition. These capabilities are driving growth in 3 main areas:

• Operational Efficiency: Without BMS, the worker must discover and reignite the extinguished burner flame, then restart the application manually. Production can also be halted for long periods of time before the extinguished flame is discovered. Both of these are easily solved with BMS. 

• Safety: The BMS assumes the risk of reigniting which would otherwise be borne by the worker

• Compliance: BMS can help reduce gas emissions by quickly reigniting a failed flame; otherwise raw gas may be needlessly vented into the atmosphere

   

Products

Overall, ProFire has traditionally had a ~50 to 58% gross margin range on products, which includes proprietary products generally more in the 60 to 70% range. Included are products which are simply resold from third parties, lowering the overall gross margins (they are more in 25% to 30% range). Management has stated that they plan to continue spending on R&D to bring on more proprietary products. To give an idea of pricing, they typically charge about $5000 per burner management system. They have tried to make some progress into midstream/downstream, but have been traditionally very upstream, at the well-head, and it appears that is still most of their revenue. 

Services 

Services are typically only 5-10% of revenue, but are important strategically. When ProFire sends people to go out and service equipment, they typically find other things that need to be fixed, driving incremental sales. Typically services generate a 20 to 35% gross margin range. 

Competitive Positioning

In their investor presentations, ProFire claims an 80% market share, and they state that they are the only public company specializing in BMS. When looking around the industry, it appears that some larger OFS companies provide these products but in more complex ways and for larger refineries than PF does. My theory is that the market in which ProFire operates is simply too niche and small for it to be worth the time of these larger companies. While this is a real competitive risk, ProFire has seen strong growth since 2008 while maintaining gross margins, and there has still been no real entry from larger refineries into this market. 

In addition, during the 2015 oil price collapse, ProFires smaller competitors suffered as the E&P sector slashed CapEx levels and reduced spending on oil field services. Thanks largely to its clean balance sheet and industry-leading market share, ProFire was able to whether the downturn and emerge with a larger customer base.

Growth Spending

At the beginning of the year, ProFire announced an expected 20% increase in OpEx from 2018 to 2019, primarily due to an increase in wages, professional fees related to acquisition activity and certifications and development of the PF2200 product. They also have plans to invest in additional sales staff for the 3100 product as well as product enhancements to our existing product lines. This includes support of the products that have recently been acquired through Midflow and Millstream. They also have the PF2200 product, which is currently in field trials is “receiving excellent reviews”, is expected to come on line in 2H 2019. ProFire has historically been successful with new product releases, and the new investments should drive top-line over the next couple years. OpEx should also come down slightly as the acquisitions are integrated. 

Other Capital Allocation

Recent M&A: In the last two months, ProFire closed on two separate acquisitions, both of which were funded through operating cash flow. ProFire’s plan is to become more and more of that one-stop shop 

In June, they acquired Millstream Energy Products which added to our robust product line. The $2.5mm acquisition of Millstream Energy Products, a privately held Canadian company that develops a line of high-performance burners, economy burners, flame arrestor housing, secondary air control plates and other related combustion components, which should add $1-2mm in revenue. Management highlighted that the product was one which they were selling before. However, they were not the manufacturer, and as such were really “at the mercy of old antiquated supply distributors and products”. 

The other acquisition, Midflow Services, LLC is an oilfield services company located in Ohio. They have steadily grown over the last few years and are one of the largest resellers of Profire burner management systems. 

Total cash spent for both acquisitions was just under US$5 million, with expected additional annual revenue of $3.5 million to $5.5 million in the coming years. 

Share Repurchases: ProFire instituted a $2mm buyback program in October, and also approved an additional $2mm share repurchase program in Q2 2019. While fairly insignificant, it speaks to the fact that management will act if they see shares as undervalued.

Near-Term Macro Headwinds Remain Major Risk

In Q2 2019, revenues decreased 11% YoY, primarily due to a 12% drop in the average oil price during the same period from Q2 2018. On the Q2 call, ProFire said they are still receiving reports that E&Ps are performing layoffs in order to streamline functions and reduce shared services and expenses. Management has acknowledged that oil prices could remain volatile in the near-mid term, with prices fluctuating from low 50s to $60 per barrel. Still, they are investing now expecting that an improved product offering will drive growth. . But overall, we have found – even through these new acquisitions, that we've been able to find customers that we haven't previously had. We've shipped a lot of product to new customers since our sales team have gone out and really hustled this past quarter. And so we're quite optimistic that we will be able to maintain well the standard of service that we offer out there and the standard of sales that we get. 

Recent Financials

Gross Margin was down 90 bps in Q2 2019 due to product mix and direct labor costs. OpEx increased approximately 10%, due to the strategic growth strategy discussed above. Management Expecting that OpEx could come in slightly below the original 20% increase. EBIT may be temporarily depressed this year as OpEx hits the income statement while investments take longer to increase top-line growth, but should increase towards the end of next year; this is something that needs to be monitored. Also note, 2018 was relatively high in terms of NWC and long-term CapEx.

Historical CF

Valuation & Conclusion

Profire is a strong cash generator, providing a niche product, with both organic and inorganic growth opportunities in the near future. Although they face cyclical headwinds, ProFire has a fortress balance sheet with no debt, and at least ~6mm in normalized FCF seems reasonable even with no earnings growth. At a 10% FCF yield on $60mm EV, the market cap would be $83mm, representing 26% upside from today’s share price. 

Risks

--M&A: The largest operational risk is ProFire’s intent to make further acquisitions and invest in new product lines. On the acquisition side, however, it seems from management’s commentary and past deals that they are primarily looking for purchases which will augment their current products and improve margin profiles, rather than dive into entirely new products. Further, acquisitions to date have been fairly small, mitigating some of the risk that they will blow their substantial cash balance on an ill-conceived acquisition. 

--Oil prices: The main macro driver of the Company’s success is of course oil prices. If it can be shown that they are stable even in the 50-60 range, ProFire should be able to easily produce historical FCF in addition to FCF from new products. If the oil environment is awful such as 2014-2016, it would be difficult for ProFire to reach that level of success. 

--Competitors moving into market: However, as discussed previously, it’s likely that this is simply too niche of a product for larger OFS providers to venture into. 

Catalyst

--Improvements in the oil pricing outlook, leading to increased CapEx from OFS companies and thereby boosted earnings for ProFire

--Strong FCF generation and subsequent tuck-in acquistions or share repurchases