NINE - Nine Energy Service Bonds Offering Attractive 16% Yield

2023-09-12 10:19:12 ET

Summary

• Nine Energy Service 2028 maturing notes are offering a price of 91 cents on the dollar with a yield to maturity of 15.9%.
• The company has experienced mixed financial performance, with increased revenue and expenses, resulting in losses before taxes.
• Despite the challenges, Nine Energy is generating positive free cash flow and aims to improve its debt structure.

Nine Energy Service (NINE) is an energy service company that specializes in oil and gas field preparation. Earlier this year, the company engaged in an unconventional refinancing of debt by offering a combination of common shares and 13% coupon notes . Today, the notes are priced at 91 cents on the dollar and are offering a yield to maturity of just under 16%. I believe these notes may be a good income investment for investors who can tolerate a little risk.

Nine Energy's profit and loss performance is mixed for 2023 so far. The company has grown revenue by $65 million in the first half of 2023 compared to the same period a year ago. Expenses are also higher, but not by as much as income from operations, which has more than doubled to $16 million compared to last year. Unfortunately, the new debt deal has increased interest expenses by the same amount as the income from operations increase. Ultimately, this means the company has lost $8 million before taxes in back to back six-month periods to start the year.

Despite the loss from operations, Nine Energy is currently generating positive free cash flow. Thanks to a change in working capital, cash flow from operations was $37 million higher than a year ago. After accounting for $12 million in capital expenditures, the company is generating free cash flow of about $19 million. In order to pay off their maturing 2023 notes, Nine Energy engaged in offering the current notes plus a $40 million draw on its ABL credit facility.

Nine Energy's balance sheet highlights the risk of the investment. All the company's assets are collateralized against debt. Shareholder equity is modestly negative at $13 million but improving. One thing that is positive is that there is over $200 million in current assets against the $332 million in long term debt. It's also positive that the company's debt structure is essentially comprised of an ABL credit facility and the 2028 maturing notes, which is simpler than many of the CCC rating companies I've reviewed. I am hopeful that Nine Energy will utilize some of its cash and positive free cash flow to cut into its ABL facility and make the 2028 noteholders the only creditors, which would be beneficial to recovery if the company were forced to restructure.

At first, I was skeptical about a company being able to support debt with a 13% coupon. In order to be able to make debt service payments on that level of debt without incurring additional borrowing, companies need to generate a return on invested capital ((ROIC)) greater than their cost of capital. In the case of Nine Energy Service, the ROIC for the first half of 2023 is greater than 15%, a good turnaround compared to a year ago.

It's important to note that Nine Energy is operating under challenging conditions in the energy market. As the company disclosed in its most recent 10-Q, energy prices impact exploration and production, which has a direct impact on their business. Oil prices have been down, but natural gas prices have been extremely low thanks to a mild winter. Natural gas prices are at pre-pandemic levels and have spent nearly all of 2023 below $3. Should a cold winter occur, or geopolitical events cause upward pressure on oil prices, Nine Energy should benefit with growth in cash flows and profitability.

Despite a difficult year in energy, Nine Energy Service is turning around its financial challenges. The company is now generating positive free cash flow and is able to service its existing debt without the need for further borrowing. With one of the highest coupons in debt markets, investors should enjoy the income while waiting for the company to complete its turnaround.

CUSIP: 6544VAE1

Price: $91.00

Coupon: 13.00%

Yield to Maturity: 15.9%

Maturity Date: 2/1/2028

Credit Rating (Moody's/S&P): NR/CCC+

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