FTK - The Prognosis For ProFrac

2023-12-01 10:49:43 ET

Summary

• ProFrac Holding Corp. shares have fallen over 70% in the past year, despite stable oil prices and geopolitical uncertainty driving oil to near $80 a barrel.
• The company's focus on the bottom line rather than the top may be partially responsible for the counterintuitive result.
• Recent insider buying by TRHC Holdings suggests a belief that the disconnect between oil prices and drilling activity will rectify itself in the future.
• A full investment analysis around ProFrac follows in the paragraphs below.

"Formula for success: rise early, work hard, strike oil ." - J. Paul Getty

Shares of oil services concern ProFrac Holding Corp. ( ACDC ) have plunged over 70% over the past year as rig counts have fallen 20% in 2023 YTD despite oil prices (CL1:COM) remaining elevated and stable. It appears that a concerted effort by C-suite executives at E&P concerns to focus on the bottom line instead of the top is partially responsible for this counterintuitive result. With further geopolitical uncertainty driving oil to near $80 a barrel, the recent insider buying merited further investigation. An analysis and recommendation follow below.

Company Overview:

ProFrac Holding Corp. is a Willow Park, Texas-based energy services concern providing well stimulation services, proppants production, and other products and services to onshore unconventional oil and natural gas producers throughout the U.S. The company has aggressively grown through acquisition, executing seven buyouts and two investments between February 2022 and February 2023. ProFrac was formed in 2016 and went public in May 2022, raising net proceeds of $301.7 million at $18 per share. The stock trades at just eight bucks a share, translating to a market cap of just under $1.3 billion.

Operating Segments:

The company views its operations through three segments (Well Stimulation Services (WSS), Proppants Production, and Manufacturing), although it also generates some revenue from its variable interest entity investments (Other).

Operating under the ProFrac banner, its WSS segment is one of the largest such providers in the U.S. with a ~12% market share from the deployment of 36 active frac fleets (a.k.a. spreads) throughout 4Q22. Frac fleets are a collection of equipment (e.g., high-pressure hydraulic pumps) that "drill a hole in the ground" and provide stimulation services by pumping fracking fluid (a mixture of proppant (typically sand) along with gel, foam, or slickwater) into bedrock formations to fracture it and draw out the oil. ProFrac also provides attendant personnel. Pricing is generally subject to the lateral length of the customer's wellbore, the number of frac stages per well, and the amount of proppant required. That said, the performance of this segment is correlated with the amount of domestic onshore drilling activity (as measured by the rig count). WSS generated 1H23 Adj. EBITDA of $328.6 million on revenue of $1.40 million.

Proppants Production operates eight mines located in three significant oil-producing regions - namely, Haynesville (four mines), the Permian (three), and Eagle Ford (one). Functioning under the Alpine Silica banner, the mines collectively have 22.8 million tons of annual sand capacity, the output of which is sold both to oilfield service providers (such as itself) and E&P concerns. The segment accounted for 1H23 Adj. EBITDA of $99.1 million on revenue of $192.0 million ($60.8 million intercompany).

Manufacturing provides high horsepower pumps, valves, piping, swivels, large-bore manifold systems, seats, and fluid ends (responsible for fluid pressure and flow to fracture the rock downhole). It also houses an engine and transmission rebuild facility and provides other maintenance work. Although these products and services are sold to third-party customers, most of the segment's output is in support of the company's WSS unit to keep outsourcing expenses to a minimum. Manufacturing was responsible for 1H23 Adj. EBITDA of $11.1 million on revenue of $98.2 million, although $86.5 million (88%) was intercompany.

Other reflects ProFrac's investment in specialty chemistry and data concern Flotek Industries ( FTK ) , which generated 1H23 Adj. EBITDA of negative $9.2 million on revenue of $100.9 million, of which $71.5 million (71%) was intercompany.

Acquisition Spree:

All these segments grew from the company's buying binge that (save one acquisition and two investments) took place after it went public. The total consideration paid out from these acquisitions was $1.85 billion, of which $1.26 billion was cash. The additions made ProFrac a vertically integrated concern with capabilities to manufacture cheaper-to-operate electric-powered hydraulic fracturing fleets, which should comprise 18% of its spread total by YE23. Legacy diesel (42%) and fuel-efficient, next-generation dynamic blending gas fleets (40%) will account for the balance.

The purchases also leveraged ProFrac's balance sheet , increasing its debt load by $864.4 million since YE21. As such, the performance of its growth-by-acquisition approach is dependent on robust capital spending by oil and gas concerns operating within its service areas. Those outlays are typically a function of oil and gas prices. However, despite oil price and natural gas maintaining $70 to $80 and $2.50 to $3.00 ranges (respectively) for a large swath of 2023, U.S. rig counts have fallen 20% from 779 at YE22 to 624 on October 20, 2023 (for reasons that will be addressed below). The company's stock price has reflected this dynamic, falling 67% from a peak of $27.00 a share achieved in November 2022.

Q2 2023 Financial Report:

There was nothing uplifting to halt the decline in its stock price when ProFrac reported 2Q23 financials on August 10, 2023, posting a loss of $2.9 million ((GAAP)) and Adj. EBITDA of positive $182.5 million on total revenue of $709.2 million as compared to a gain of $16.2 million ((GAAP)) and Adj. EBITDA of $247.1 million on revenue of $857.5 million in 1Q23, representing sequential declines of $19.1 million, 26%, and 17%, respectively. Per share comparisons are not informative due to the conversion of Class B stock into Class A stock during 1Q23, which significantly altered the diluted share count. The 2Q23 per share loss of $0.02 was $0.23 shy of expectations while the top line missed by $2.5 million.

Management indicated that it was applying the brakes to its acquisition strategy in light of its customers' collective reluctance to drill. Although it was optimistic about 2H23, falling rig counts impelled the company to reduce headcount and (on October 2, 2023) publicly consider a sale or public offering of its Alpine Silica subsidiary to unlock value and reduce debt. ProFrac's own spread count is suddenly under wraps, with management no longer divulging that metric in its last two quarterly reports. After achieving an average of 36 fleets in 4Q22, the company stated that its average count was slightly higher in 1Q23 and cuts were made in 2Q23 and early August 2023.

Third Quarter Results:

ProFrac posted its Q3 results on November 9th. The company posted a GAAP loss of 21 cents a share, which resulted in a net loss of $17.9 million for the quarter compared to a loss of $4.6 million in the previous quarter. Revenues fell 19% on a year-over-year basis to $574.2 million. ProFrac continued to right-sized its active fleet count in August to optimize calendar efficiencies, increase utilization, and reduce costs. The company also produced nearly $75 million of free cash flow in the quarter and paid down debt by nearly $123 million over the three-month period.

Balance Sheet & Analyst Commentary:

The company ended the quarter with approximately $25 million in cash and marketable securities on its balance sheet and paid down its long-term debt to just over $900 million.

Street analysts are a mixed bag on the ProFrac's prospects, featuring three buy or outperform ratings against three holds with a median price target of just under $12 a share. On average, they expect the company to earn $0.56 a share ((GAAP)) on revenue of $2.74 billion in FY23, followed by $1.58 a share ((GAAP)) on revenue of $2.82 billion in FY24.

TRHC Holdings, LP, which represents the interests of the Wilks family - including Chairman of the Board Matthew Wilks and CEO Ladd Wilks - has used the low price level as a buying opportunity, adding 603,478 shares at $9.09 on October 17, 2023. The transaction brought the fund's total position to 72.24 million shares, or 45% of the total outstanding. There was another just over $6 million purchase on November 10th.

Verdict:

The Wilks family is seeing a disconnect between oil prices and drilling activity that it expects to rectify itself via market forces over the ensuing quarters, while the most recent round of geopolitical uncertainty has driven oil above $80 per barrel. Normally, when oil prices move meaningfully higher, every available rig is sought by E&P concerns to drill, usually resulting in a peak in oil and gas prices, followed by a meaningful move lower. This boom-and-bust cycle in the oil patch is nothing new. However, with fund managers increasingly leery of investing in erratically performing concerns combined with tepid to zero investment from the ESG zealots, the C-suites at E&P have assumed a more restrained approach, focusing increasingly on their bottom lines instead of the top. Certainly, the current administration's policy of restricting leasing and drilling on federal lands has also had a psychological and financial impact. The question becomes: what price compels the E&P industry to revert back to its old ways?

That question is currently unanswerable, but what is more evident is that if there is a meaningful decline in oil prices, ProFrac's prospects will not improve. That said, with the domestic E&P concerns behaving more like OPEC, the chances for a meaningful decline have lessened meaningfully. On an EV/TTM Adj. EBITDA basis, ProFrac's stock is attractive at under 2.5 but less so on a PE basis (14 on FY23E EPS) as the interest expense from its debt takes a big bite out of earnings. A proppant segment sale notwithstanding, the company's stock becomes attractive if a technical signal emerges indicating that the rig count has bottomed, or oil moves above $90. While awaiting one of these events, the recommendation is to stay on the sidelines for ProFrac Holding Corp.

"Oil may run out, liquidity may dry up, but as long as ink flows freely, the next chapter of Life will continue to be written ." - Alex Morritt

For further details see: