Description

ProPetro (PUMP) was last written up nearly a year ago. I believe that in the subsequent 11 months, there have been material improvements in the fundamentals of this company which has transformed it from a mediocre investment opportunity to one that is now notably attractive.

While I acknowledge pressure pumping companies do not typically benefit from favourable long term industry economics and I am by no means an energy specialist, my investment thesis here can be independently simplified - falling CAPEX, stable demand, clean balance sheet and changing capital allocation strategy towards significant buybacks.

Brief Overview - ProPetro operates as an oil field services business focused on downhole pumping services, which include hydraulic fracturing, cementing and wireline operations. Revenues are concentrated in hydraulic fracturing services, however, efforts to provide a holistic service to customers has led to bolt on accretive M&A such as the acquisition of Silvertip to gain access to the wireline market and slightly offset revenue concentration. 

In May 2023, the board of directors approved a $100 million buyback program, and the company commenced repurchasing shares immediately, acquiring just under $40 million worth over two quarters, leaving around $63 million available to purchase (equivalent to approximately 7.5% of today's float).

The maths here is simple; for the thesis to work out, all one needs is a reasonably depressed valuation and an understanding of cash flow stability.

Cash flows - The stability of cash flows into the future, will depend on market demand dynamics. As ProPetro is a services based business it is less sensitive to the fluctuations in the price of oil and gas, however, they are sensitive to rig count and holes drilled. 

The latest Baker Hughes rig count data shows the number of rigs operating in the Permian has trended lower from 365 in March 2023 to 311. Oil production is currently at an all time high of roughly 13.5 million barrels per day, yet rig counts across the United states are trending lower cycle over cycle.

I attribute these dynamics to a shifting mentality among upstream producers. With the emergence of ESG and the hawkish narrative surrounding oil and gas, operators have switched to focusing on developing efficiencies, streamlining processes and cutting head counts. Despite lower rig count numbers, those holes are drying up quicker creating an interesting dynamic where oil continues to flow consistently benefitting upstream margins despite lower active rigs.

Moving forward, consider that cash flows are set for a decent tailwind as the company begins unwinding their growth CAPEX for the next couple of years. ProPetro currently has second generation, top of the line equipment after 3 years of spending. Analysts are forecasting CAPEX to return to prior levels of roughly $200 million which would create a $150 million tailwind to free cash flow. CAPEX levels have already begun to drop in 2023 and these are expected to pick up pace in 2024.

The company currently sits on $62.5 million in cash and has historically operated with negative working capital suggesting they also have room to pull at least $50 million out of working capital. Interest bearing debt is low at $45 million bringing the risk profile of the company down significantly.

Valuation - Relative to industry averages, ProPetro is cheaper across almost all metrics and the cheapest TBV and EV/EBITDA versus all other competitors. The company benefits from a very clean capital stack with little to no debt, hence why it is not trading at the lowest PE.

An interesting comp to highlight is LBRT which, over the past 5 years, has been the outlier of the group in terms of equity performance despite slightly worse off metrics than PUMP. I believe this is directly related to the capital allocation strategy to allow for the repurchase of shares from time to time when the market has presented an attractive buying opportunity for LBRT management. At the current PE multiple, ProPetro could feasibly manage to repurchase roughly 12.61% of the float per year without harming their balance sheet or increasing the leverage of the business. This, without a doubt, stands as the primary value proposition for ProPetro. 

I value ProPetro at approximately 87% above today's price, however this does not include the potential for a significant reduction in the outstanding shares of the company. Consider a 25% reduction of share count, in this scenario the fair value of the stock would increase to approximately $20 or 159% above the most recent close.

I feel ProPetro is a very basic investment opportunity to grasp, its cheap with a changing capital allocation strategy that’s occurring with growing free cashflow. Given the depressed tangible book value, I believe the downside to be limited from here with the highest risk bring opportunity cost if the share price does not appreciate significantly. 

Catalyst

- Each incremental share repurchased should create significant value for shareholders

- Further board approval