Description

Investment Thesis

Profrac (PFHC) is a compelling long at current prices with 30-60% upside over the coming 6-18 months and potentially sooner given strong North American energy tailwinds.

The company is a pure-play, vertically integrated pressure pumper, sporting one of the newest, most energy efficient fleets in N. America and operating across multiple basins. Given high energy prices and strong fundamentals we anticipate a multi-year upcycle in North American fracking activity at a time when the services supply chain is capacity constrained after years of consolidation and rationalization due to weak commodity prices. PFHC is well positioned to benefit as a large incumbent, with a relatively new fleet, manufacturing capability to build and service their fleet, and with an experienced, and heavily invested management team. The company IPO’d recently (5/13/22) and due to multiple factors, including its inauspicious IPO timing, trades at a significant discount to peers. 

While we historically have not been enamored with pressure pumping businesses, we see PFHC as a good way to gain exposure to the N.A. energy cycle. Energy services fundamentals tend to lag by 6-12 months, and we foresee a strong cycle with significant pricing power through 2023 and beyond. With an undemanding valuation, and poised for significant growth, we see PFHC as a compelling name in what seems likely to continue to be a difficult investing environment. 

Description: (from S-1: https://bit.ly/3mteFVd )

We are a growth-oriented, vertically integrated and innovation-driven energy services company providing hydraulic fracturing, completion services and other complementary products and services to leading upstream oil and gas companies engaged in the exploration and production (“E&P”) of North American unconventional oil and natural gas resources. Founded in 2016, ProFrac was built to be the go-to service provider for E&P companies’ most demanding hydraulic fracturing needs. We are focused on employing new technologies to significantly reduce “greenhouse gas” (“GHG”) emissions and increase efficiency in what has historically been an emissions-intensive component of the unconventional E&P development process. We believe the technical and operational capabilities of our fleets ideally position us to capture increased demand resulting from the market recovery and our customers’ shifting preferences favoring the sustainable development of natural resources.

Our operations are primarily focused in the West Texas, East Texas/Louisiana, South Texas, Oklahoma, Uinta and Appalachian regions, where we have cultivated deep and long standing customer relationships with some of those regions’ most active E&P companies. We operate in three business segments: stimulation services, manufacturing and proppant production. We believe we are the largest privately owned, and second largest overall, provider of hydraulic fracturing services in North America by hydraulic horsepower (“HHP”), with aggregate installed capacity of over 1.7 million HHP across 34 conventional fleets, of which, as of March 31, 2022, 31 were active, reflecting a net installed capacity of approximately 1.5 million HHP across our active fleets.  

(When we refer to a “fleet” or a “frac fleet,” we are referring to the pumping units, truck tractors, data trucks, storage tanks, chemical additive and hydration units, blenders and other equipment necessary to perform hydraulic fracturing services, including back-up pumping capacity.)

Vertically Integrated Operator

PFHC benefits from being a vertically integrated operator all the way down to owning its own Frac sand mines and manufacturing and servicing operations to retrofit, upgrade, and service its fleets efficiently. As such, the company is extremely well positioned to benefit from the likely cost push inflation that is and will occur by virtue of strong demand and constrained supply across the supply chain. The company is well positioned to manage its costs, gain pricing leverage as supply tightens, and maintain very high operating rates. Our thesis is predicated on strong margin growth over the coming quarters as demand for fleets increases.

Principal Shareholders (from S1: https://bit.ly/3mteFVd )

The Wilks are our principal shareholders. Prior to founding ProFrac in 2016, the Wilks founded the predecessor to FTSI in 2000, which they grew into one of the largest North American hydraulic fracturing companies based on HHP before selling their interest in that business in 2011. Combined, Dan Wilks and Farris Wilks have more than 75 years’ experience in the energy and energy services sectors.

Upon completion of this offering, the Wilks will beneficially own approximately 49.6% of our Class A common stock and approximately 96.5% of our Class B common stock, collectively representing approximately 84.8% of the voting power of the Company. In addition, THRC Holdings and the Farris and Jo Ann Wilks 2022 Family Trust have indicated that they may collectively purchase in this offering an aggregate of up to $117.0 million, or 5,200,000 shares (based on the midpoint of the price range set forth above), of our Class A common stock at the price to the public. Assuming THRC Holdings and the Farris and Jo Ann Wilks 2022 Family Trust purchase an aggregate of 5,200,000 shares of Class A common stock, the Wilks will beneficially own approximately 64.5% of our Class A common stock and approximately 96.5% of our Class B Common stock, collectively representing approximately 88.5% of the voting power of the Company. 

Thoughts on Dual Share Class Structure 

We view the concentration of ownership as a mixed bag. We don’t like class B shares giving owners disproportionate voting power. We do like that management has material skin in the game and is incented to create value for themselves as well as shareholders. We like management’s investment vehicles showing confidence in the company’s prospects by purchasing a material amount of stock in the IPO. This likely signals that management won’t be sellers of stock until there is meaningful appreciation from the initial IPO range which was around current prices. 

Recent Developments 

The company recently completed an IPO raising upwards of $250mm. The majority of proceeds were used to pay down company debt. Much of the debt was issued to fund recent M&A transactions including a March 2022 buyout of pressure pumping competitor FTSI for $407mm ($334mm in debt, and 73mm in stock). Incidentally, the Wilk family founded the predecessor company to FTSI. Similarly, the company purchased a Texas sand reserve and is building infrastructure for a proppant facility.  

Historical Financials

Environmental / ESG factors

E&Ps are increasingly sensitive to enivonmental/ESG factors. More than 50% of PFHC’s fleet have dual fuel capabilities and 40% have Gen IV engines which are in strong demand compared to 100% diesel engines which are both expensive and heavy emitters. The company enjoys a cost (~30%) and speed advantage by building its own equipment, and currently has 2 e-frac fleets under contructuction which, once completed can be immediately deployed at premium rates. Similarly, the company is upgrading 5-10 engines per month to tier IV (from tier II) dual fuel capabilities. 

2022 Fleet Mix

Source: Company reports and J.P. Morgan estimates

Competitive Dynamics / Fleet Counts

Industry wide fleet count in 2022 should average about 250 fleets and 12.8mm HHP, which equates to an operating rate of 95%+. The industry is plagued by old equipment which ensures that whatever new capacity can be added will be offset by retirements and dispositions. The industry has been plagued by lack of adequate investment for many years, culminating in 2020 during the COVID scare when oil prices went negative. Much of the current industry fleet is aged and smaller operators typically have been surviving by starving their cap-ex budgets. Equipment makers were forced to rationalize their capacity and will not be able to quickly scale capacity now that demand is rebounding so robustly. PFHC’s fleet ranks favortably relative to their peer average adding a source of competitive advantage both in profitability as well as capability available to E&P customers. 

U.S. Average Frac Fleet Age

(Number of service providers by average frac equipment age)

Source: Rystad Energy as of March 2022. Metrics are reflective of total U.S. market. Fleet age calculated based on manufacture date for total fleets

Industry Structure 

Industry consolidation has been consistent over the past decade as weaker operators folded and/or sold out. Currently 60% of the Lower-48 fleets are concentrated in the hands of the top 4 operators, including PFHC.

Fleet Count (active) by operator 

Source: Rystad, Company Filings, J.P. Morgan estimates.

EV/EBITDA Comps 

Source: Bloomberg Finance, L.P., J.P. Morgan Estimates (as of Fri 6/3/22)

FCF Comps

Source: Bloomberg Finance, L.P., J.P. Morgan Estimates (as of Fri 6/3/22)

Valuation

Based on our ’23 projection for 949mm EBITDA at 5x 2023 EBITDA (in-line with comp valuations), PFHC would trade at $35.66 or a 56% return from current prices. The stock currently trades at a 1.7 turn discount to comps (on ‘22 projections) due to its lack of operating history as a public company, and its inauspicious IPO timing. We expect the company to execute well given its newer, higher quality fleet, and strong customer relationships, and vertically integrated model. In time we expect the company’s multiple to approach or exceed its comps given its many competitive advantages.      

Our forecast assumes average fleet EBITDA increases from about $8mm in 2021 to $16.5mm in 2022 and yet higher (to $21mm) in 2023, reflecting a robust pricing environment as supply tightens and capacity utilizations reach maximum levels. Similarly, we expect the company will enjoy strong growth in manufacturing ebitda as well from proppant sales, albeit those remain ancillary to company revenues mostly driven by fleet EBITDA.

Annualized Fleet EBITDA, historical and projected 

Source: Company reports and J.P. Morgan estimates. Assumes fluid end capitalization.

Financials

Risks
- Geopolitical event or recession that negatively impacts energy demand and prices

- Unfavorable regulation or taxation regarding fracking, pressure pumping, or general oil and gas production

- End to Russia/Ukraine conflict and Western resumption of buying Russian oil and gas 

- Loss of major customer 

Summary

Profrac (PFHC) is a compelling long, given its advantaged position as a pure play pressure pumping company with a young fleet and strong fundamentals. The company is somewhat orphaned due to its IPO occurring during the week the market bottomed in early May. The company trades at a significant discount to its peers despite its vertical integration and superior fleet. We expect the entire group to continue to benefit as demand grows and supply remains tight. Profrac’s stock can appreciate on both a relative and absolute basis as the company executes on its fairly straightforward operational plan. We see an opportunity for a 30-60% return over the coming 6-18 months.  

Catalyst

- Effective Execution 

- Improvements in Pressure Pumping Pricing  

- Positive Engagement with the Investment Community 

- Strong Energy Pricing