Tom Varesh: Our focus at M Partners is on North America. We are specifically bullish on the oil and gas sector in western Canada. Many of its pipeline projects, oil sands projects and natural gas projects are now approved, and many other projects are in various stages of being green-lighted. We predict that 2014 is going to be a better year for the oil and gas sector than last year, and '15, '16, '17 are set up to experience significant growth in this region because a wide range of projects are attracting a lot of capital investment.
TER: Are there impediments to ramping up this growth during the next two or three years?
TV: At a macro level, regulatory approvals have to be obtained for many of these projects to go ahead. At the micro level, the larger oil and gas companies have to decide on a timeline for pushing significant amounts of capex into the projects. The base price of the oil and gas commodities has to make sense to warrant large capex, but the discount that western Canadian producers get should shrink as a result of building out the pipelines and related infrastructural themes.
"A wide range of projects in western Canada are attracting a lot of capital investment."
I cover infrastructure niche plays and construction dealership companies in the oilfield infrastructure segment in western Canada. Services are seeing a significant pick up in activity—it is basically all hands on deck for the booming economy in Alberta and other provinces in western Canada.
TER: Within this space, are there dominant firms that are making acquisitions and driving up the potential value of energy service juniors?
TV: The rollup theme is very prevalent. WesternOne Inc. (WEQ:TSX) and Enterprise Group Inc. (E:TSX.V) both have the currency to roll up private enterprises working in the service sectors in western Canada. Other acquisitive firms include Entrec Corp. (ENT:TSX.V) , McCoy Corp. (MCB:TSX), Petrowest Corp. (PRW:TSX) and Macro Enterprises Inc. (MCR:TSX.V), just to name a few. These are publically traded companies with access to the capital markets—with access to equity, debt or bank financing. And they are actively and steadily rolling up the smaller private companies.
TER: Why is there an influx of acquisition capital into this space?
TV: With more and more investors looking for alternative investment options that are not based in metals, capital is generally gravitating toward the oil and gas infrastructure sector. WesternOne and Enterprise Group have already benefited from recent successful capital raises and it's full steam ahead for both of them.
These companies not only have the cash to make acquisitions, but they also have the ability to immediately invest in the operations of the acquired companies and grow their organic lines of business. Private companies are often starved for capital—and therein lies the opportunity. The acquisition strategy keeps picking up, and we expect to see double-digit organic growth from the acquiring firms during the next five years.
TER: Do you have a top pick?
"Enterprise Group Inc. is a great infrastructure play—it is very acquisitive and it is our top pick!"
TV: Enterprise Group is a great infrastructure play—it is very acquisitive. In 2012, it bought a heating business called Artic Therm. It also owns TC Backhoe, which does a lot of pipelining and cable laying for utility companies in Alberta. And it acquired Calgary Tunneling last summer. At the start of this year, Enterprise closed on Hart Oilfield Rentals. This group of service-related companies can cross-sell their services to their major oil field clients in western Canada.
TER: In terms of blending these acquisitions into the corporate structure, is Enterprise functioning as a holding company, or is it doing hands-on management with daily operations at its new acquisitions?
TV: I characterize Enterprise as a hands-on management entity. In the not-too-distant future, we will likely see a rebranding of this corporation and each of its businesses. The reason that Enterprise will rebrand is to demonstrate that it is very active in each of the business segments. Each of the managers or previous owners of those various businesses is still running operations under the Enterprise umbrella. The executive management team at Enterprise is making the capital allocation and the growth strategy decisions in concert with the managers running each business unit. It is a very collaborative effort intended to grow each business and to cross-sell the services.
TER: How has the Enterprise Group's stock been performing over the past period?
TV: When we launched on Enterprise a year ago, the stock was at $0.35. It is now in the $1.10 range. That is great performance, and there is more to realize in the stock as it proves out the earnings potential of its recent acquisitions. Our current target price for Enterprise is $2.25—and it is our top pick!
TER: What other service juniors do you like here?
TV: WesternOne is an oil and gas infrastructure play with two distinct business lines. About 55% of its revenue is driven by its manufacturing business, Britco. Britco builds out modular work camps and offices for mining and oil and gas companies. One of its biggest repeat clients is Devon Energy Corp. (DVN:NYSE). And Britco is working on another contract for Devon in northwestern Canada. The other side of its business model caters to rentals and propane sales. It has a large heater rental business, which competes with Enterprise's Artic Therm. But WesternOne provides the propane to run the heaters, unlike Artic Therm. It has a well-integrated business and it has been performing quite well since it did its initial public offering in 2006.
TER: WesternOne's stock has fallen a bit over the last year. Why?
TV: WesternOne expanded into Australia at the start of 2013. It acquired a company similar to Britco that makes modular workforce camps. With the general downturn in mining, that business underperformed and dragged down the earnings. Management has taken steps to rationalize this business line, and it is on track to exit 2014 as a profitable entity. While the WesternOne stock went sideways during the last 12 months, we expect it to firm up as it becomes clear that the Australian business unit is turning around.
The neat thing about the WesternOne story is its high dividend, which currently yields 8%. This is a story where investors are paid to wait and the dividend has been stable since 2007. Indeed, the dividend has increased twice since the firm went public and it is now steady at $0.60 per year. The payout ratio is expected to be 60% this year—which is up from 41% last year (due to the losses in Australia). We fully expect the payout ratio to fall back into the low 40% range in 2014. Our target price for WesternOne is $9.35.
TER: What other firms do you favor in the energy services space?
TV: The two names we've touched on thus far are $100–$200 million ($100–$200M) market cap companies with high growth profiles. If an investor is looking for something in the large-cap space, we really like Finning International Inc. (FTT:TSX). Finning is strictly a dealership business model. It sells Caterpillar construction and mining equipment in western Canada, South America, the U.K. and Ireland.
TER: What are the fundamentals for success in the heavy equipment dealership business?
TV: Finning's success is largely tied to what is going on at a macro level in the Canadian oil and gas sector. About 55–60% of its revenue is from western Canada, selling into the oil sands industry and the construction industry. Alberta and western Canada—the prairies—are going to lead Canada in terms of GDP growth. That dovetails nicely into the Finning story because growth is accompanied by infrastructure spending and buildouts. That means there are steady sales of construction and mining equipment in the oil sands and also in the conventional gas sector in Alberta.
In South America, Finning's equipment is used to mine copper and gold. While metal prices have come off and that sector is facing a reduction in capital expenditures, we continue to like Finning because of its recurring revenue theme. During the last half-decade, Finning has sold so much equipment in Canada and South America that iron in the field has risen by nearly 40%. And that equipment generates recurring revenue for Finning's parts and maintenance services, which generate high margins. Finning is on track to ramp up its product support revenue to 50% of its overall revenue. It ended 2013 with product support at 46% of revenue—which was up from the prior year's 42%. Finning's product support revenue will continue to grow so long as metal mines and oil sands keep producing. Finning is expected to generate significant free cash flow in 2014; I believe the company will increase its dividend this year. A solid investment, we say.
TER: Are the share prices of the three firms that we have talked about today tied to the volatility of the oil and coal and fossil fuel investment markets?
TV: These share values are tied indirectly to oil prices and, in the case of Finning, to copper and gold prices as well. To the extent that commodity prices remain strong, share price activity will remain strong.
TER: Thank you for your time. Tom.
TV: You're welcome.
Tom Varesh was rated the #1 Ranked Industrials Analyst by Bloomberg in 2010 and 2011, and he is consistently ranked in the Top 3. He was the #1 Ranked Canadian Industrials analyst in 2010 by First Coverage Equity Research Analyst and has worked as an analyst for over 10 years at two different investment banks, Canaccord Capital (now called Canaccord Genuity) and M Partners. Varesh covers equipment dealership companies (infrastructure and agriculture), infrastructure services companies and equipment rental companies. He is often interviewed by and quoted in the National Post, The Globe & Mail, Bloomberg, BNN, CNBC and other media outlets. He was previously an investment advisor for four years at a Big Five Canadian Bank for retail, commercial and corporate clients.
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1) Peter Byrne conducted this interview for The Energy Report and provides services to The Energy Report as an independent contractor. He or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Energy Report: Enterprise Group Inc. Streetwise Reports does not accept stock in exchange for its services or as sponsorship payment.
3) Tom Varesh: I or my family own shares of the following companies mentioned in this interview: None. I personally am or my family is paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: Enterprise Group Inc. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
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