Some Thoughts on Oil & Gas Activity – International

As an investor, I look for mispriced bets. I tend to be somewhat industry agnostic as long I feel that I can get an understanding of the mechanics of the industry. Though I like to take long term concentrated bets on individual businesses, I have taken top down bets when I feel it’s appropriate. Parts of the Oil & Gas industry is something that I feel I understand well enough to commit capital to. As such, I follow the rig count consistently to sniff out a potential disconnect between share prices and activity. I prefer to find more service focused companies rather than producers, so the focus on marginal drilling activity drives the businesses.

This post will take a quick look at the industry with a emphasis on international rig count.

Demand

Like any commodity, oil is subject to supply and demand. Though there are differences in the types oil in the various geographies, oil supply and demand should be looked at globally (in my opinion of course). When prices stay below the marginal cost to extract oil then we see underinvestment and vice versa when prices are high.

Here is one (of many) sites that provides supply and demand numbers.

Supply

Obviously the cost curve is important. Below is a global comparison with the average cost of production in 2020.

You can purchase a very detailed report here, although I just stole the free image.

Looking at the cost curve at a set point in time can be misleading. Currency fluctuations, transportation infrastructure, refinery capacity, remaining reserves, unplanned additional supply, depletion rates, EV transition cadence, local government agendas and political risks are some of the thing I try to keep in mind when investing in the space. EIA gives regular updates like this one.

Historical Prices

Of course, price drives investment. Though this post talks about International rig count, I can only find inflation adjusted data for WTIC. Regardless it provides some interesting context.

OPEC

You can’t google anything related to oil without getting a bunch of news on OPEC and what they are doing or planning to do with supply. Understanding the intentions of OPEC at any point in time is difficult. Countries come and go, production is raised or lowered, and sometimes the countries can’t agree on production quotas.

I have no advantage over anyone else in predicting what OPEC will do or won’t do. Therefore, I don’t trade off short term news and expectations. I wouldn’t go so far to say that I ignore what OPEC is doing, but I tend to focus on what happens and what the impacts are after that. I have made premature decisions when OPEC says they will raise or lower production, only to get caught off guard when it doesn’t happen.

Rig Count Globally

Interesting to see the role that the various geographies have played in the contribution to the total rigs being utilized. Also noting that the total rigs deployed peaked in the 1980s. Given the equipment required to extract oil has only increased in complexity, we can see how many drilling rigs are needed today relative to the past. One could make the argument that we are underinvesting in oil discovery and production today, but the count is still lower throughout the 2000s than the late 1970s and early 1980s.

Looking at the previous chart in an area form, the US drilling activity from the 1970s proportional looks pretty impressive.

The spillover effects from the 1973 oil embargo made a lasting impact through time, though it was officially lifted in 1974. The devaluation of the US dollar coupled with the supply reduction drive prices higher. I’m going to go a little more about the US into this in a separate post.

When removing North America from the global rig count with monthly data rather just annual average, gives an interesting perspective on activity. The Middle East has been growing rig count while Latin America is utilizing lower than previous.

How I Think About the Industry

I have found that over the years I utilized EIA more and more as I tend to find myself following data and not speculation on what will or won’t happen. Understanding the type of investor I am and my behavior to news and price swings is important if I want to commit capital to the industry. I find the focus on service companies, having a 9-24 month timeframe, invest with high integrity management teams, focus on stable balance sheets and keeping positions small is the what works for me.

Anyone else follow the rig count closely?

Dean

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Aug 2021 Update – $CSW/B.to, $OSS.v, $REPH, $ISDR, $ISV.to, $STC.v, $VMD.to, $SYZ.to, $MCB.to, $FRII.to, $MTLO.v, $SVT, $FXC.to, $PZA.to, $URB/A.to, $MCR.v, $KUT.v

TIKR

I use TIKR to quickly look through ideas and check comparable companies. Would recommend. Referral code below.

https://app.tikr.com/register?ref=smob7c

Thoughts on Market Activity

Nothing constructive.

What I’m Reading

I have been reading the book Scarcity. I am enjoying it. Coming from a place of privilege it frames decisions made by those who may have a harder path than my own.

Posts this month

Developments on Companies Mentioned

  • Corby Spirit and Wine Limited – $CSW/A.to & $CSW/B.to
    • Reported fiscal Q4 2021
      • Q was in line with expectations
      • Compression in margins for the quarter due to higher opex
  • OneSoft Solutions – $OSS.v
    • Reported Q2 2021
      • Not much has changed
      • Rev was up with an easy comp
      • Still waiting on some significant news with new customers  signing
  • Recro Pharma – $REPH
    • Reported Q2 2021
      • Showing gradual improvement in operations
        • Verapamil seems to have stabilized
        • Some initiatives underway on business development and clinical trial services
      • Reaffirmed guidance of 68-72 mil and 15-17 mil adj ebitda
    • Purchase of IRISYS
      • 50 mil total
        • Half in cash
        • 6.1 debt
        • Remaining in 9.3mil shares
      • Interesting addition, but comes with dilution
        • Not sure if the ebitda and revenue guidance included this purchase
      • They will provide a more comprehensive update on the Q3 call
    • I’m continuing to monitor
  • Issuer Direct – $ISDR
    • Good q
      • Decent top line growth
      • Private market customer growth up 50%
      • Margins at high end of range
        • Sounds like they are sustainable from this level
      • Looking to continue to invest in products to drive ARPU higher
  • Information Services Corp – $ISV.to
    • Reported Q2 2021
      • Rev up 44% from low base last year and Paragon acquisition
      • Real estate activity in sask is really helping
      • Some delays due to governments focused on covid and economy
      • Paragon likely sees a gradual increase in activity when subsidies are wound down late in the year
  • Sangoma Technologies Corp – $STC.v
    • Announced timing of an Annual and Special shareholder meeting to approve a share consolidation and (eventual) US lisitng
  • Viemed – $VMD.to
    • Reported Q2
      • Rev growth and patient growth returning but not to pre-pandemic levels
        • Expect more growth in H2
      • The company is working to train their sales reps to better support patients with remote monitoring
      • They are also getting prepared in case there is another wave of lockdowns and their sales reps will have a harder time reaching physicians in hospitals
      • Covid related revenue is winding down as expected
      • No material update from OIG findings
      • Guidance was for about 10% yoy core biz growth
  • Sylogist – $SYZ.to
    • Reported fiscal Q3 2021
      • Below my expectations
      • Going to keep an eye on it
        • Currently yields 4.6%
  • McCoy Global – $MCB.to
    • Reported Q2 2021
      • Rev was weaker than expected
      • They had a delay in recognizing an order which made the top line look worse
      • They have had strong orders for the first month of the quarter
      • MCB has been a company that sees activity recover later than many other service companies so not surprising we aren’t seeing strong top line growth
      • They continue to invest in their digital roadmap
      • PPP loan was forgiven
  • Freshii – $FRII.to
    • Reported Q2 2021
      • The majority of the quarter had heavy lockdowns so the quarter is not a good one to measure the business although provides some insight into what mgmt. think of the business
      • They are trialing some new things like energy bites
      • They are driving more revenue from dinner
      • They committed to investing in supporting franchise partners with another 1mil
      • Still have lots of cash – waiting to see what they do with this
      • I am holding and will wait for the company to demonstrate it’s ability to execute during a more normal environment
  • Martello Technologies Group Inc – $MTLO.v
    • Reported fiscal Q1 2022
      • Was weaker than I expected
      • Expenses increased quicker than I expected
      • Hurt by higher $CAD
      • The conference call did have some positive things to say
    • I have been following for a couple of quarters since I sold shares, so far it was a good decision
    • I’m going to stop updating MTLO here, but keep an eye on it offline
  • Servotronics – $SVT
    • I’m no longer following this closely – I won’t do a deep dive unless it trades at a discount to NCAV
  • FAX Capital – $FXC.to
    • Reported Q2
      • Book value at the end of Q2 is $5.45 per share which is up nicely
      • Still have over 80mil in cash to deploy
  • Pizza Pizza Royalty Corp – $PZA.to
    • Reported q2 2021
      • Still plugging along
      • Increased the distribution by 9%
      • Increased store count by 5
  • Urbana Corp – $URB/A.to
    • Reported Q2 2021
      • Still trades at large discount to NAV
  • Macro Enterprises – $MCR.v
    • Reported Q2 2021
      • Better than I expected
      • Gave guidance to near 300mil in revenue in 2021
        • Was 250mil
      • Was carrying an extra 20mil in receivables at the end of the quarter that they received after the quarter ended
    • Continuing to hold
  • RediShred Capital – $KUT.v
    • Reported Q2 2021
      • Was a good q and ahead of my expectations
      • Lots of positive comment on the call
      • Acquisition pipeline strong

Long $OSS.v, $ISDR, $STC.v, $VMD.to, $MCB.to, $FRII.to, $FXC.to, $URB/A.to, $MCR.v, $KUT.v

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RediShred Capital Corp – $KUT.v

I have finally filled out a full position in KUT. I thought now would be a good time to write a post on it and welcome feedback.

Ticker: KUT.v

Price: $0.71 CAD

Shares Outstanding (diluted): 79.6 million

Market Cap: 56.5 mil CAD

Estimated EV: 77.5 mil CAD

Insider Ownership: 25%

EV/Est EBITDA: 8x (my estimated EBITDA)

Background

RediShred Capital Corp., together with its subsidiaries, manages and operates the Proshred brand and business platform in the United States and internationally. It operates through three segments: Franchising and licensing, Corporate Locations, and Corporate. The company grants and manages shredding business franchises under the Proshred trademark; operates in corporate shredding businesses; and supports the franchises. It also provides shredding and disposal of electronic waste services; sells recycled paper and other recyclable by-products, such as metals and plastics; and resale of certain electronics. The company was incorporated in 2006 and is headquartered in Mississauga, Canada.

The company has over 30 locations across the US and they are the 3rd largest destruction company.

Competition

The marketplace is highly fragmented with a few large players. KUT focuses on on-site shredding which is different than larger players like Iron Mountain and Shredit who focus on off-site. There are over 700 independent operators in the US, most with less than 2 trucks.

Customers typically subscribe to regular/recurring services. They have approximently 50% of their expected revenue scheduled.

Senior Mgmt

Jeff Hasham is the CEO. He has been the CEO since 2011 and has been a critical part of the business and executing their growth plan. He had a brief stint as the CFO from 2005 to 2008. He owns just above 1% of the common shares. The value of his shares is about 3x his salary. He is also on the board.

Kasia Pawluk has been the CFO since 2011 and has been with the company since 2010. She owns 115k shares which is about 50% of her latest annual salary.

Compensation for CEO and CFO is about 60% salary and 40% variable. The variable is split fairly evenly between short and long term incentives. 75-80% of the variable compensation is based on per share and per location metrics. The targets include balance sheet metrics to prevent the business from being overlevered.

They are quite conservative in their reporting compared to most companies that I follow. They don’t include any subsidies in their reported ebtida metrics. I like management team that are this transparent.

There are some change in control measures as well.

Board

  • The board is comprised of 8 members.
  • 6 of the board members are independent, including the chair.
  • 5 of the board members have franchise or franchise management experience.
  • The independent directors own about 15% of the common shares.
  • Total non-employee fees totaled a little over 250k in 2020.

Growth Prospects

They have a few ways to drive profitability.

  • Drive same location top line and margins.
  • Purchase existing franchise partners or independents.
  • Support franchise partners directly.

The primary driver of growth is acquisitions. They either buyout existing franchise partners or independents. Given that the existing franchise partners have increased visibility, the multiples are based on ebitda and/or revenue. They typically range from 5-6x ebitda. Franchises typically run at around 2million in revenue and 30-35% ebitda margins. There are currently 16 franchise partners that are potential acquisitions over the next 2-3 years. KUT makes a logical succession plan for operators that are looking for an exit.

The independents tend to be asset based with more emphasis on post acquisition profitability. As mentioned there are over 700 independents that also provide possible acquisitions. These acquisitions can provide increased route density, streamlining of marketing initiatives, lowering back office functions and potential below market price for trucks.

Acquisitions are paid for with a mix of debt and cash. They also like to use earn-outs as a large portion of the purchase price. I like the approach as it requires less capital upfront and allows to make multiple acquisitions a year.

So far this year they have made 2 acquisitions (if you don’t include the Proscan Massachusetts that was effective December 31, 2020). Both have been at the target multiples mentioned.

In addition to typical shredding and information destruction, KUT has a small Ewaste initiative. This is only available in Kansas and Chicago via their Secure e-Cycle division. This allows businesses to dispose of electronics in an environmentally friendly manner. They also have the potential to refurbish and resell the electronics. To me this demonstrates some entrepreneurial spirit and scrappiness inside the business.

Risks

  • Paper prices – for recycled paper can be volatile and may cause margins to swing higher or lower in the short term.
  • Access to and cost of debt – since they rely on debt to fund acquisitions, if the currently low interest rates rise rapidly it will increase interest expenses.
  • Share issuance at inopportune prices – at some point they will likely need some additional capital for acquisitions. If they have a hard time raising capital, this will hurt per share numbers.
  • Equipment – they could need to replace a large portion of the trucks in a short time frame and it will soak up some capital that could be deployed towards acquisitions.
  • Franchise partners may not want to be acquired – there is a chance that many of the franchise partners will not want to transition under the KUT umbrella.
  • Lack of independents to acquire – the independent opportunities may no present themselves. KUT relies on picking up some operators under distress. Increased subsidies may support independents longer than a more typical environment.
  • Covid & lockdowns – of course we are in a pandemic. Reopen could be delayed and hurt profitability in the short term.
  • Multiples – this is not a brand new sexy business that designs EVs, mines crypto or is disrupting the financial services industry. These types of businesses tend to get lower multiples, especially if they trade on the venture.

Summary

To me, KUT sets up as a reasonable bet if you have a longish timeframe. They provide a fundamental service to businesses, customer churn is low and their earn reasonable return on capital under a more typical business environment. The path to higher top line is straight forward and derisks the story from my vantage point. They just need to execute the existing plan and you can see a path to a higher share price a few years out. The management team is well versed on the industry, strong at operations, and compensation is aligned with shareholders interest.

DKAM owns a little over 14% of the common as well.

The CEO did an interview with the SCD team earlier this year. It is worth watching if you are interested in the company.

Q2 results should be out in a couple of weeks and should provide some additional color on what to expect for the remainder of 2021 and how the acquisition integrations are going.

Anyone else own KUT?

Thanks,

Dean

*I am long shares on KUT at time of writing.

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