|Shares Out. (in M):||51||P/E||3.3x (ttm)||0.0x|
|Market Cap (in $M):||88||P/FCF||0.0x||0.0x|
|Net Debt (in $M):||-13||EBIT||28||0|
|TEV ($):||76||TEV/EBIT||2.8x (ttm)||0.0x|
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High Returns for High Arctic?
High Arctic Energy Services Inc. (TSX: HWO) is an oilfield services, drilling and equipment rental business headquartered Red Deer, Alberta Canada. While based in western Canada, the company has significant operations in Papua New Guinea (PNG). High Arctic provides snubbing services, nitrogen services, specialized drilling, drilling management and rental equipment. Despite several unique characteristics, I believe an investment in High Arctic could provide significant potential upside with important downside protection in its asset base.
High Arctic is currently trading at the following metrics:
|As Stated||Fully Diluted|
|TTM P/E||2.94 x||3.25 x|
|P/TBV||0.99 x||1.10 x|
|EV/EBITDA||1.87 x||2.10 x|
The company appears to be quite cheap for the following reasons:
Asset and Business Summary
Papua New Guinea
On a ttm basis 63.6% of the company’s revenue has been derived from operations in PNG. A significant portion of these revenues came from its relationship with Oil Search Limited (ASX: OSH). In the first six months of 2012, OSL represented 62% of revenues and in 2011 and 2010 OSL was 48% and 55% of revenues respectively. Oil Search is a $9.9 billion Australian company with a long history in PNG. It has operated there since 1929 and the PNG government is currently a 15% shareholder in the company. It also happens to own a 29% interest in the PNG LNG Project which is currently being constructed with Exxon Mobil as the 33% owner. You can see their most recent presentation… http://www.oilsearch.com/Investor-Centre/ASX-Releases/Presentations-and-Webcasts.html. OSL is projecting a more than four-fold increase in PNG production as it begins to deliver gas for the PNG LNG Project between now and 2015. High Arctic would appear to be a significant, trusted participant in that growth. High Arctic has several other smaller customers in PNG, including InterOil Corporation.
Obviously PNG and the customer concentration is a significant risk, but it is also a significant opportunity. The biggest component to the company’s work for OSL is the management and operation of OSL’s drilling rigs in the country. The two rigs being managed, known as 103 and 104, are heli-portable rigs (the only two in the country). For the last several years High Arctic has been managing drilling operations for OSL under a semi-long term contract. The agreements for both rigs currently run through December of 2013 and there was some price consideration given to OSL by High Arctic in the most recent negotiation. Interestingly, the arrangement calls for the simultaneous operation of both rigs beginning in October of this year for the first time in over a year. This should provide a significant tailwind.
PNG is a difficult country in which to do business. Dealing with a difficult government and local tribal populations are just part of it. Of course the flipside to that coin is that there are few service operators in the country and several sources have described the very nature of the country as a “barrier to entry.” High Arctic has operated in PNG for eight years now and has a significant lead on new entrants, entrants which I believe would have difficulty generating the trust needed to win over operators in the country, especially on the eve of LNG gas operations. In addition to items previously noted, extremely difficult terrain, maddening logistics, government bureaucracy and difficult weather all contribute to this “barrier.”
Recent political headlines have not helped the perception of PNG in the international community, as the recent dispute over who was Prime Minister lead to elections a few months ago. You can’t make this stuff up! While it makes for spectacular headlines in the press, it seems to be business as usual in PNG according to long-time residents and business participants in the country. It appears that this recent episode has been resolved, but this could again become an issue. Developments over the last 12 months have appeared not to disrupt LNG development operations.
The association with PNG may very well be a tailwind. As mentioned previously, Oil Search has plans to significantly expand its production in the country. This will no-doubt involve High Arctic. Additionally, it appears that the PNG LNG operation is being expanded. Recent results from P’nyang South drilling suggest at least one additional train is feasible for the current two train design for PNG LNG. While OSL is not the operator here, drilling operations in P’nyang would require heli-portable rigs which OSL owns. High Arctic was the drilling manager on the initial drilling in the area.
High Artic is currently expanding its operation beyond drilling management in the country, most importantly in the rental and support services areas. Efforts in this area include matting and miscellaneous rental business and camp management.
An important conversation with a senior level drilling manager at Oil Search suggested the following:
High Arctic is the largest snubbing operator in Canada and is a significant operator in the independent nitrogen services business. As noted previously, snubbing has been associated historically with gas well. Interestingly, in Q1 the company noted that 80% of its snubbing work was directed at oil wells and utilization has remained fairly consistent over the last couple of years despite the ongoing declines in natural gas prices. The process is used for workover and completion activities and while a competitor so to speak with
coil tubbing, it allows for intervention in the well bore while it is still under pressure. And while clearly the business would benefit from more activity in the western Canadian gas business, increasing pressure from long horizontal wells and additional drilling demands appear to be driving increased demand from oil well drilling. Snubbing utilization, which is disclosed separately, has average about 40% over the last several quarters.
The nitrogen business is currently operating under much more favorable conditions. Utilization over the last several quarters has been approximately 77-80%. Nitrogen is also used in completion and workovers for a variety of purposes, including well stimulation, pressure testing, EOR, pressure maintenance and gas lift. The company is investing more heavily in this side of the business.
The company has first call agreements with Encana and Shell in Canada, two of the country’s most active participants. These agreements speak to the credibility of the Canadian operations.
Final Comment on Valuation
I’ve chosen not to present a very formal presentation on valuation. My argument is that with the metrics currently present and the potential tailwinds in North America and PNG, the valuation at these prices appears to be mistaken. I consider it a one foot hurdle. It doesn’t take very large multiples to generate substantial returns for an investor at current prices. For reference, a 5x multiple on fully diluted ttm NI per share gets you to $2.67 (54% return) and a 7x multiple gets you to $3.74 (116% return). Of course the ttm NI figure used in that calculation is mostly not burdened by taxes, as it will be for several years. With management (current and former) and a large controlling shareholder clearly incentivized alongside me, I like the chances of success at these prices.
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