Description

I have enjoyed some of the recent write-ups and discussions of energy stocks that appear to be trading as if oil is still sub-$50 per barrel.  I think Ranger is another idea to consider in this vein.  It ticks many boxes I like – broken IPO, limited financial leverage, strong asset backing, aligned management/ownership, under-earning, and a cheap valuation. 

Background

Ranger Energy Services (RNGR) is a deep value long that has been more or less abandoned by public markets.  The company IPO’d in August of last year in order to raise equity to purchase assets.  Life as a public company has not gone very well: there have clearly been internal issues around integration, and the company took down expectations massively the first time they reported in November 2017.  They followed that up with a so-so print in March, leading the street to abandon the stock, having done the usual MO of super bullish initiations post IPO, leading to downgrades as numbers have missed (compare and contrast the Credit Suisse initiation with subsequent notes, for example).

The stock has been killed, trading for roughly half of the post-IPO range, and valuation is getting to what I think is a very compelling level.  Market apathy is high, as is common in a busted IPO, but the company is turning a corner and the stock should begin to reflect improved operational performance.  Oil trading at $70+ doesn’t hurt either.  I think RNGR could easily get back to the mid-teens later this year or next.

Secular Sweet Spot

Ranger’s main business is well servicing, which historically was workover rigs going in and fixing issues with existing wells. Well servicing was one of the last segments of the oilfield services market to begin to inflect upwards in terms of activity and price, and pricing still remains 20-25% below 2014 levels. Utilization is steadily improving, and because of the changing demands on well servicing rigs, the active population of rigs that can actually do the work customers want is much smaller than headline capacity. Competitor Basic Energy Services said the market was “at virtually at full utilization” in their recent earnings release. Pricing has started to tick higher, by perhaps high single digits in the first quarter, and more is on the come. The change in the market has been driven by the trend towards longer laterals for shale wells. Now, higher spec well servicing rigs are being used to do completion work for 10K foot laterals. Ranger’s asset base is focused on the rigs that have the capability to do this kind of work.    More completions work is driving higher revenue and better margins: completions are done 24/7, whereas more traditional workovers are done during daylight hours Monday-Friday.

The other interesting and longer term opportunity for Ranger relates to the rapidly increasing population of shale wells hitting 4+ years in age. Older wells have more frequent mechanical issues that require a well servicing rig to fix. The population of older shale wells will climb from 50k today to over 100k by 2020. This large population of older wells should generate a longer tail of demand that is less dependent on current oil prices and should be somewhat less cyclical. It will also soak up any remaining lower spec workover rig supply, further tightening the market.

Turning the Corner

Ranger just reported first quarter numbers, and a clear inflection in the business is evident. Revenue grew by 25% quarter on quarter, vastly outpacing most peers, while margins expanded, utilization improved, and average revenue rig per hour grew by 7%. Despite a weak January as a result of weather, the company reported $5 million of EBITDA in Q1, which beat sell side expectations, and based on the strengthening environment should be able to do between $8 and $9 million of EBITDA in Q2. Hitting that level of EBITDA generation on a quarterly basis makes 1) 2018 full year EBITDA estimates of $32 million very achievable and 2) gives me increased confidence the company can achieve or beat 2019 full year EBITDA estimates of $48 million.

Cashflow was admittedly weak in the first quarter, but entirely driven by a build in accounts receivable related to a startup wireline business (complementary to the workover rigs), and the working capital drag should has already reversed in the second quarter. If you assume an 80% conversion of EBITDA to operating cashflow, then the company should generate ~$25mm of operating cashflow for the remainder of the year. Capex should be in excess of that by $10-$15mm (mostly growth capex this year), so the revolver balance should increase to ~$25 million by the end of the year. The exciting part is that they stop taking delivery of new-build rigs at the end of the year, so capex should drop dramatically in 2019. Maintenance capex for this business is roughly $10-$15 million, so if Ranger generates the forecasted level of EBITDA in 2019, free cash before any growth investments should be ~$25-30mm ($1.60 - $1.90/sh). That implies a forward fcf yield of something like 20%.

Cheap Valuation on Earnings Power and Assets

On 2018 estimates, Ranger trades at 5x EV/EBITDA and around 3x on 2019 estimates. Peers Key Energy Services and Basic, which are levered and burdened with older, less capable rigs, trade at higher multiples. Basic trades at 5.7x 2018 estimated EV/EBITDA and 4.2x 2019 estimated EV/EBITDA. Key trades at 12.6x estimated 2018 EV/EBITDA and 6x estimated 2019 EV/EBITDA. Ranger should probably trade at a premium to both, but even at what I think is a reasonably conservative 5x multiple on 2019 numbers, the stock would be ~$15.

You can also take comfort from the fact that the asset value of the company supports a similar price target. The net asset value of Ranger, assuming a value of roughly $2mm for their workover rigs (current price out of the factory), is somewhere north of $15 per share.  As the payback period on a new build rig is roughly 4 years, implying 20-25% returns, at a minimum the stock should trade at replacement value, if not at a premium.  Tangible book value is $11/sh after the company wrote down all of its goodwill last quarter (note the B shares are the non-controlling interest on the balance sheet – book value is $185.4mm divided by the 15.8mm A+B shares).

Any strategic competitor looking to invest in new equipment should instead look at buying Ranger and getting the rigs for half price.  Ranger would be a great acquisition candidate for either Key or Basic – they could do an all equity deal, de-lever their respective balance sheets, and high-grade their rig fleets at the same time.  In any case, Ranger has turned the quarter operationally and I think the stock is quite cheap down here.

Aligned Management and Ownership

Ranger is still majority-owned by Charles Leykum’s CSL Capital (and related entities).  They put the business together at a much higher cost basis than at which the stock currently trades, and are unlikely to be sellers anywhere near current prices.  The chairman is Peter Miller, who was the chairman and CEO at NOV.  RNGR’s CEO is Darron Anderson (age 48) who has built and sold energy-related companies in the private market.  Ranger was clearly put together to be a roll-up/growth vehicle in the oilfield services sector, and they may continue to look for acquisitions.  I don’t think they want to put much leverage on the company, and don’t think they will use their stock as a currency at these levels.  The focus over the next year should simply be on execution and proving out the earnings power of the current asset base.

Risks/things to be aware of

-          Jobs Act IPO.

-          Up-C structure with TRS.

-          “Material weakness related to lack of sufficient qualified accounting personnel” (in all filings including and since the S-1).  The large inside ownership and “adult supervision” from the sponsor CSL give me some comfort with this.

Legal Disclaimer

 We had long exposure to RNGR at the time of submission.  We have no obligation to update the information contained herein and may buy or sell shares at any time for any reason. We make no representation or warranties as to the accuracy, completeness or timeliness of the information contained in this presentation. We expressly disclaim all liability for errors or omissions in, or the misuse or misinterpretation of, any information contained in this presentation.  This does not constitute an advertisement or an offer to sell or a solicitation of an offer to buy any securities.

Catalyst

-          Continued EBITDA growth (driven by utilization, pricing, and mix improvement to more completion work).

-          $25-30mm of FCF generation in 2019.