Civeo Corp. (NYSE:CVEO) provides lodging services to the energy industry: the company operates facilities in the Canada oil sands, in Australia serving the metallurgical coal mining industry, and (a small item) in the Bakken. Recent declines in the energy commodities involved have led to serious share price declines. The first analytical task is to estimate earnings in the event energy prices recover toward their former levels.
Pro Forma Data
From a January 2015 presentation:
Note the inclusion of information from periods prior to the spin off. Working with the 3&3/4 years presented, average EPS works out to $1.69. There is $775 million of debt, taken on since the spin off, which would reduce EPS by 17 cents, at an interest rate of 2.4%, so potential EPS in recovery would be $1.52.
Cutting that in half, and applying a P/E of 12.5, a target price of $9.50 comes into view, with timing dependent on oil prices. From Friday’s close of $3.95, allowing 2 years for recovery, the return would be 55% annualized. If it takes 4 years, it would still be a very respectable 25%.
Shares traded as high as $24 last year. As of this moment, there’s no point in speculating about the possibility they will return to that high water mark. Let’s give it some time, see if they can make $9, and take it from there.
Soft Patch Coming Up
As of the January presentation date, EBITDA for 2015 is estimated at $135 to $160 million, meaning the company will be cash flow positive but is unlikely to report a profit.
It would be reasonable to expect that the company will take a careful look at asset values when wrapping up 2014. Write-offs or impairments are likely. Analysis going forward should focus on EBITDA.
The company anticipates refinancing its debt. The situation could become tense if this isn’t handled expeditiously.
Most of the business comes from Canada:
Noting the US (Bakken) revenue is only 5% of the whole, the easiest way to look at it is to write it off mentally.
Canada (oil sands) is the key here. As a way of getting a window into that area, I read the Q4 2014 earnings conference call (transcript) for Suncor (NYSE:SU) which is a major player, but not a customer. CEO Steve Williams said the company has been planning for WTI well less than $100 for some time now, and continues to be optimistic over the long-term. Production will continue, while development activity is time-consuming and will be modulated but not dropped. A cost figure of $34.45 per barrel was mentioned, for existing production.
Berkshire Hathaway (NYSE:BRK.A) held a position in Suncor while dropping Exxon (NYSE:XOM). I regard that as evidence that the oil sands are economically viable long-term, so that lodging for the labor force involved will also be profitable.
In Australia, metallurgical coal demand is expected to increase about 4% in both 2015 and 2016. Prices are under pressure. Australian operations generated 25% of revenue and 33% of EBITDA during 2013. There is exposure to gold, LNG and iron ore as prospective growth avenues.
Because the business is predominantly Canadian, the company expects to migrate to that country during 2015, to include a change of corporate domicile. This will achieve operational and financial efficiencies.
At the same time, it will open the door for refinancing, placing the debt and liquidity with operations. This is important, as debt is an issue here.
Long term debt consists of a 5 year bank loan of $775 million, with interest at 2.4% as of the most recent quarter, and principal to be reduced 1.25% per quarter. On that basis, debt service will total $39 million per year, well within EBITDA.
There is also a $650 million revolver, undrawn as of 9/30/2014.
As of the 3Q 2014 10-Q, the company expected to be in compliance with covenants over the next 12 months. Total debt to EBITDA is restricted to a 3.5:1 ratio. Based on January 2015 expectations, mid-range EBITDA is $148 million, calling for total debt of less than $518 million.
The credit agreement entered into in May 2014 is now problematic. The presentation linked above mentions that the company anticipates refinancing the current loan structure as part of the migration to Canada.
US banks as a group are no doubt overextended in the oil patch. The distinction between US and Canadian assets and operations may get swamped in the negativity emanating from highly leveraged players in the shale oil industry. It’s possible that Canadian banks will be more receptive and have a better understanding of Civeo’s potential.
It’s frequently possible to negotiate waivers or modified terms when covenants are in danger of being breached. There is a cost involved. Projected EBITDA is sufficient to pay interest and reduce debt, and physical assets greatly exceed debt, so the situation appears manageable. This item needs to be watched: both the 10-K when filed and the earnings conference call should be monitored carefully.
The company’s assets consist of lodging constructed for the use of a workforce that will eventually move on to other boom towns. The salvage value of the structures is difficult to estimate, and may be trivial.
Checking depreciation, the estimated useful lives of lodging assets are 3 to 15 years, which looks realistic. Noting that the company has reported profits even in the face of rapid depreciation, EBITDA is strong enough to pay interest and reduce debt.
Oil sands production is unpopular with environmentalists, and rightfully so. However, the Canadian populations and governments involved accept the activity, and it is economically viable, as well as important from a geo-political point of view.
Oil is subject to considerable geo-political tension, and strategically Canada may be regarded as a friendly source of the energy necessary to fuel the US economy.
The capital structure (debt) was developed when oil prices were considerably higher than they are at present, as discussed above.
Strategy and Tactics
The situation is volatile, and the share price moves with oil on a daily basis. The stock is optionable, although open interest isn’t very large and bid/ask spreads were wide at the strikes I would be interested in. Under the circumstances, I prefer to buy the stock rather than fiddle with options.
I opened a starter position, 40% of normal size, and was filled promptly at the ask. 4Q 2014 earnings are due on March 13, and the conference call should provide some visibility into the coming year. It will be important to see if they have more of their facilities booked, and whether progress has been made on the planned migration and new financing arrangements.
There will be several quarters to play it by ear here. The headline risk of write-downs or negative news on refinancing may result in gaps down. It may be possible to average in at lower prices, or to achieve greater clarity about future prospects before shoving more money across the line. Two additional increments of 30% each are in reserve, and can be deployed if the situation warrants.
A Digression on Locating Prospects
Attempts to invest responsibly in the current environment can be frustrating. Restricting the spectrum of possible investments to blue chips, while commendable from a safety point of view, leads one into a cul de sac where iconic companies either underperform or are priced at nosebleed levels, or both. It’s easier, and possibly more productive, to speculate. I have a speculative account, separated from my regular investments by a mental firewall.
Using Portfolio123, I developed a custom formula, $HiLo. It’s the 52 week high divided by the 52 week low, and the higher it is, the more speculative the prospect. I ran a screen for $HiLo greater than 2, and restricted it to the Energy sector, pulling up 50 names from the S&P 1,500. Eyeballing the output, there were a number of familiar names, old friends from 2009-2010, among which was Oil States International (NYSE:OIS).
My past experience with that stock was a happy one, so I took another look, and found it overpriced, when taking into account the spin off of the business that is now Civeo. I had good luck buying low with California Resources (NYSE:CRC) which was spun off from Occidental (NYSE:OXY) and promptly tanked. Of course Civeo was spun off from Oil States, and tanked just as promptly, and more severely. The situations are similar.
From there it’s a well worn path, locate a presentation with some pro forma financials, develop an opinion on normalized earnings, take a look at the debt that goes along with the spin off, and estimate the possible risk/reward.
I spent several hours running backtests, and learned very little. There were no other criteria that would work with $HiLo to produce serious alpha, and no cutoff or range to separate the wheat from the chaff. I already knew that if you invest in that type of thing at a market bottom you will do well.
The S&P 500 is not at a bottom, but the Energy sector is possibly in the vicinity of one, and may be on the other side of it. As such, the risk/reward is good. At best, stocks of this type will produce multi-baggers: at worst, they will bounce several times on their way to oblivion, providing exit points along the way.
Probably sticking with old friends, or situations similar to what worked in the past, will improve odds. I like Civeo at the current price, as a speculative investment. It is not suitable for investors who cannot tolerate substantial loss of capital.