WTTR - Select Water Solutions Consolidates Operations For Greater Capital Efficiency

2023-10-09 15:06:32 ET

Summary

• Select Water Solutions, Inc. provides water management services to oil & gas companies in the U.S.
• The company may benefit from increased return of capital to shareholders.
• The stock appears undervalued and has potential for growth in the medium term.
• My outlook for Select Water Solutions is a Buy at around $7.70 per share.

A Quick Take On Select Water Solutions

Select Water Solutions, Inc. ( WTTR ) provides a range of water management services to oil & gas exploration & production companies in the United States.

I previously wrote about WTTR with a Buy outlook.

While top line revenue growth may be muted due to capital-conscious E&P customers, the stock may benefit from increased return of capital to shareholders.

I reiterate my Buy outlook for WTTR at around $7.70 per share.

Select Water Solutions Overview And Market

Houston, Texas-based Select Water Solutions’ predecessor entity was founded as Peak Oilfield Services, LLC and began operations in 2007, changed its name to Select Energy Solutions, went public in 2017, and changed its name again to Select Water Solutions.

Chairman, President and Chief Executive Officer John Schmitz founded the firm and has been in the oilfield services business for several decades.

Schmitz is also the founder of B-29 Holdings, his family office that contains privately held interests in a variety of oil & gas investments.

Select Energy has operated in three primary segments:

• Water Solutions

• Water Infrastructure

• Oilfield Chemicals.

According to a 2023 market research report by Mordor Intelligence, the global oil & gas water management market is expected to grow at a compound annual growth rate of 8.3% from 2020 to 2025.

The rise of unconventional oil and gas production, along with stringent regulatory requirements, is expected to increase the demand for water services in exploration & production phases.

The company has said that its water inventory sources are a "key competitive advantage" by being able to offer the large volumes of water necessary in hydraulic fracturing operations.

Furthermore, the water services part of the support system to E&P customers is still fragmented and largely composed of many small firms, who typically don’t offer an integrated suite of services.

Major oilfield services firms provide water services, but do so as a side business rather than their primary focus.

Major competitive or other industry participants include:

• Halliburton

• Schlumberger

• Baker Hughes

• Ovivo

• Aquatech International

• Veolia.

Select Water Solutions’ Recent Financial Trends

Total revenue by quarter has continued to rise year-over-year; Operating income by quarter has risen materially as well.

Gross profit margin by quarter has trended steadily higher; Selling and G&A expenses as a percentage of total revenue by quarter have remained flat in recent quarters.

Earnings per share (Diluted) have trended unevenly higher, as the chart shows below:

(All data in the above charts is GAAP.)

In the past 12 months, WTTR’s stock price has fallen 1.53%:

For balance sheet results, the firm ended the quarter with $10.6 million in cash and equivalents and $65.0 million in total debt, all of which was categorized as long-term.

Over the trailing twelve months, free cash flow was $16.5 million, during which capital expenditures were a whopping $108.1 million. The company paid $16.1 million in stock-based compensation in the last four quarters, the highest trailing twelve-month figure in the past eleven quarters.

Valuation And Other Metrics For Select Water Solutions

Below is a table of relevant capitalization and valuation figures for the company:

(Source - Seeking Alpha.)

Below is an estimated DCF (Discounted Cash Flow) analysis of the firm’s projected growth and earnings:

Based on the free cash flow DCF, the firm’s shares would be valued at approximately $8.65 versus the current price of $7.75, indicating they are potentially currently undervalued.

Sentiment Analysis

The chart below shows the frequency of keywords in management’s most recent earnings conference call:

The chart illustrates that the firm is experiencing the negative effects of macro headwinds filtering through to reduced rig counts and well completions.

Analysts asked leadership about what is driving margin improvement, M&A prospects, and the utilization levels of the firm’s existing water infrastructure sites.

Management said that the firm is improving its water services margins through operation efficiencies and implementing more technology.

The company is not focusing on M&A prospects at the moment, instead, it is looking to continue to expand and connect its existing infrastructure footprint, which tends to increase capacity.

Utilization of its water infrastructure remains at only 50% - 60%, although the company is working to ‘tie in more customers’ to its system.

Commentary On Select Water Solutions

In its last earnings call (Source - Seeking Alpha ), covering Q2 2023’s results, management’s prepared remarks highlighted improvement in free cash flow and reductions in its working capital requirements.

The company repaid a substantial portion of its debt, and management expects to be debt-free by the end of the year.

Management intends to finish out 2023 focused on previous acquisition integration efforts, restructuring its water infrastructure efforts to focus on ‘brownfield pipeline and disposal projects and greenfield recycling facilities.’

Total revenue for Q2 2023 rose by 20.5% year-over-year, and gross profit margin increased by 4.5%.

Selling and G&A expenses as a percentage of revenue dropped by 0.5% YoY, while operating profit tripled to $26.3 million.

Looking ahead, consensus full-year 2023 revenue growth expectations are at 16.8%.

Management appears to be focused on increasing operating efficiencies and generating solid cash flow to pay down debt and provide shareholder returns.

Potential upside catalysts to the stock could include increased stock buybacks and greater fracking activity in the U.S.

However, rig counts in the Permian Basin have shown a drop in recent months despite elevated oil prices, as this chart from YCharts illustrates:

E&P companies operating in major U.S. fracking areas have shown greater spending discipline than in past years, likely due to the changing makeup of companies to larger, more capital-conscious players rather than smaller, more aggressive ones.

The firm's revenue growth rate is likely capped in the short term in light of continued capital discipline from E&P majors.

However, management’s capital efficiency efforts bode well for supporting the stock in the medium term.

I reiterate my Buy outlook for Select Water Solutions, Inc. shares at around $7.70 per share.

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