WTTR - Select Water Solutions: An Undervalued And Overlooked Way To Play The Oil Sector

2023-10-11 13:56:05 ET

Summary

• Select Water Solutions focuses on water infrastructure and treatment services in the oil and gas industry, contributing to environmental sustainability.
• Over the past six quarters, the company has completed 12 acquisitions, adding substantial revenue. They have effectively reduced the risks associated with acquisitions and aim to maintain a debt-free balance sheet.
• The company currently trades at an attractive P/E ratio of 12.6x earnings, with the potential for further improvement as they optimize acquisitions and apply cost reductions.

The oil industry is so huge that it offers investors multiple ways to play the sector. While the direct and more popular ways to get involved are in exploration, drilling, refining, and transportation one of the more overlooked ways is in Oil field Services. However, a well-managed business can become a good investment regardless of how overlooked the industry is. I believe Select Water Solutions ( WTTR ) is one such business that is looking quite attractive considering the valuations it is trading at and how critical this company is for the services it provides for the Oil and Gas industry in the United States.

The environment would agree with their business model

Select Water Solutions operates as a water-focused solutions provider with a strong emphasis on water infrastructure and treatment services. This segment provided 77% of the revenues in 2022. The company's business model for their primary segments is primarily centered around:

Water Infrastructure Services: Select Water Solutions specializes in the construction, maintenance, and repair of water infrastructure. This includes services related to pipelines, pump stations, and other critical water-related assets. They work with various clients, including municipal water utilities and industrial facilities, to ensure the efficient and reliable distribution of water.

Water Treatment Solutions: The company offers water treatment solutions that encompass a range of processes designed to improve water quality. This may involve technologies for filtration, purification, and remediation to address issues such as water contamination or wastewater treatment.

23% of the revenues came from the Oilfield Chemicals segment which provides a full suite of chemicals used in hydraulic fracturing, stimulation, cementing, pipelines, and well completions. What I liked about their business model is that Select is the only company in the industry with integrated full life cycle water & chemical solutions. The full cycle plays a big role in bringing sustainability to this industry. Essentially, this company performs a big role in cleaning up after the oil and gas majors and has a leading market share position across most of its service capabilities in every U.S. basin.

Their contribution to environmental sustainability through water conservation and efficient water management strategies reduces water waste and minimizes the environmental impact of water-intensive operations. Their involvement in water treatment reduces the pollution of natural water bodies. All in all, their work helps its clients comply with environmental regulations related to water usage and discharge.

Growth through acquisitions

Over the last 6 quarters, the company has completed 12 acquisitions adding annualized run-rate revenue of more than $400M which would explain the revenue chart below.

1. Non-core divestments and asset sales exceeding $100 million have substantially reduced the risks associated with acquisitions since 2019, and additional sales are anticipated in 2023.

2. It expects a debt-free balance sheet by the end of 2023

3. Debt to Equity ratio at 8% is negligible. It is really impressive that the company has been able to maintain this position all the while growing its revenues through acquisitions by almost 45% when compared to the pre-pandemic quarter (Q1 2020)

4. The company has started returning value to shareholders and initiated dividend payments in 2022. It expects to maintain this due to improving earnings and growing cashflows. It has also used its cashflows to buy back shares but it has to be mentioned that it is not sufficient enough at this point to bring down shareholder dilution.

Valuation

The company currently trades 12.6x earnings and this could significantly come down in the future as the company optimizes its acquisitions, and applies cost reductions while developing synergies across its acquisitions. I looked for any guidance from the company and the only thing that popped up was their guidance for gross profit before D&A which they hope to increase for Water Services and Chemical technologies segment from 44% to 50% in 2024. So not much help here.

Our best shot at estimating forward ratios then remains to evaluate their PE and EV/EBITDA for a range of scenarios. Since they are already improving their profitability and EBITDA through cost efficiencies from acquisitions, we expect them to continue along this path successfully. So our range of scenarios will vary based on the degree of success.

If we are assuming in the most optimistic scenario they will end up improving their earnings and EBITDA by as much as 50% then we see the ratios drop as low as 10x and 3x respectively. On the other end, if we expect no change to either their earnings or EBITDA (highly unlikely given the trajectory we are seeing) then we will remain at 12.6x and 4.6x respectively. In any case, we are far below the medians of the industry (15x and 8x)

Risks of the Oil and Gas Industry

This industry is cyclical and known for its boom and bust cycles. Some of these cycles have been brutal and the stats would scare anyone. More than 100 oil and gas companies declared bankruptcy in 2020 and almost 150 bankruptcies occurred during the oil bust of 2015-2016. The Great Recession had rolling effects on the industry much after 2010. Most of these companies were operating in or below mid-cap space as these are the ones that are most susceptible to going bankrupt in a downturn. This is why we were extra careful in our analysis of our balance sheet, and we ensured that this company is having no problems there. But still, an investor would need to be aware of the drawdown this stock can present in case we see another downturn in this industry recession or otherwise.

Wrapping up

I believe Select Water Solutions is a buy for the following reasons:

• Select Water Solutions helps oil companies have a sustainable and environmentally friendly usage of water, and this is becoming increasingly important in our world. They have also continuously proven that they can get better at managing water.
• Their growing through acquisition strategy is showing signs of paying off and they are already a leader in their space
• They are growing through acquisition while being prudent in their balance sheet
• Their valuation is attractive and will continue to get more attractive as their operational synergies through their acquired companies get stronger, in my view

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