Pat McKeough recently replied to a Member of his Inner Circle who wanted to know about a Canadian energy stock with growing operations but a falling share price.
STEP Energy Services provides coiled tubing for energy firms that use horizontal fracturing, or “fracking,” to extract oil and gas. The company’s equipment is designed to serve the deepest and most challenging wells. It operates in both Western Canada and the southern United States; this year it expanded its U.S. operations with a key acquisition. The company’s revenue rose in the most recent quarter, reports Pat, and it continues to report positive cash flow. But he notes that a slowdown in Canadian drilling and stiff competition among U.S. drilling companies have hurt this stock’s share price. And its high debt adds risk.
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Q: Pat, what’s your advice on STEP Energy Services? It seems to have business on both sides of the border, which I would have thought would help it in the current oil and gas market.
A: STEP ENERGY SERVICES (symbol STEP on Toronto; www.stepenergyservices.com) is an oilfield service company, founded in 2011, that provides coiled tubing (very long metal pipe spooled on a large reel), and other products and services for fracking.
Oil and gas drillers use horizontal wells to carry out fracturing, or “fracking,” on so-called “tight” gas and oil formations. Most of that drilling occurs in sand, coal and shale. These mineral deposits are too dense or “tight” to let the gas or oil they contain flow freely into the well. Fracking cracks the formation and releases the gas and oil.
The company’s Canadian services are focused in the Western Canadian Sedimentary Basin, while in the U.S., it focuses on the Permian and Eagle Ford shale areas of Texas and the Haynesville area of Louisiana.
In Canada, STEP provides a range of well services, but mainly coiled tubing services for completing new wells or improving already- producing wells. STEP’s Canadian coiled tubing units are designed to service the deepest wells. The company currently operates a fleet of 13 coiled tubing units in Western Canada. STEP’s Canadian fracturing business is primarily focused on the deeper, more technically challenging areas of Alberta and northeast B.C.
The company also performs work on oil properties in eastern Alberta and southern Saskatchewan. STEP currently operates eight fracturing spreads (mobile factories with all the equipment needed to carry out hydraulic fracturing) representing 225,000 horsepower in Canada.
Energy stocks: $355 million acquisition expands operations in U.S. fracturing market
In the U.S., the company’s business started by offering coiled tubing services to exploration and production companies in 2015. STEP currently operates a fleet of eight coiled tubing units. On April 2, 2018, the company acquired Tucker Energy Services for $355 million. That let it expand its operations in the U.S. fracturing market.
The purchase included four fracturing spreads (representing 192,500 horsepower), two coiled tubing units, and 15 wireline units (a cabling technology used by operators of oil and gas wells to lower equipment or measurement devices into the well for the purposes of evaluation, pipe recovery and so on).
In the three months ended September 30, 2018, STEP’s revenue rose 37.0%, to $240.5 million from $175.5 million. The gain came mostly from the Tucker acquisition. The company reported cash flow of $9.3 million in the latest quarter. That was down 21.0% from $48.3 million. Cash flow per share fell 28.8%, to $0.57 from $0.80, on more shares outstanding. The decline was due largely to higher costs, as well as a slowdown in Canadian drilling activity.
STEP’s long-term debt of $288.2 million, is a high 235% of its currently depressed $122.5 million market cap.
The company continues to report positive cash flow, and its move into the U.S. market provides diversification. Offsetting that is the slowdown in Canadian exploration and development activity. U.S drilling continues to expand, but competition among oil and gas servicing companies is keeping prices low.
That has hurt the share prices of most resource services stocks—including STEP, which is down 83% since May 2018. The company’s high debt is also a risk factor.
Inner Circle recommendation: STEP Energy Services is okay to hold, but only for highly aggressive investors willing to wait for a rebound in Canadian oil and gas drilling.
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