- Trading below tangible book value with decent operational and growth trends.
- Positioned for additional energy and infrastructure spending in the Mid-Atlantic region.
- Undervalued due to minuscule ~$20m market cap, which makes it “uninvestable” for institutional firms.
- Management has a large stake and a history of being shareholder friendly.
- High potential for margin expansion, revenue growth, and increased shareholder returns.
Energy Services of America is a dirt cheap holding company with exposure to two different types of infrastructure. Based in Huntington, West Virginia ESOA operates two service companies, CJ Hughes for pipeline construction and maintenance and another, Nitro Electric which handles electrical and mechanical services. Revenue split is about 50/50.
From the 10-K issued in December:
Wholly owned subsidiary C.J. Hughes is a general contractor primarily engaged in pipeline construction for utility companies. C.J. Hughes operates primarily in the mid-Atlantic region of the United States. Nitro Electric, Inc. (“Nitro Electric”), a wholly owned subsidiary of C. J. Hughes, is an electrical and mechanical contractor that provides its services to the power, chemical and automotive industries. Nitro Electric operates primarily in the mid-Atlantic region of the United States.
CJ Hughes builds and maintains but does not own intrastate pipelines and sewer systems in the vicinity of the Marcellus Shale. So we’re looking at a relatively asset-light, regionally focused subsidiary, which services some pretty big corporate energy, chemical, and utility names, as well as some (probably more predictable) municipal and state customers.
Energy Services’ customers include many of the leading companies in the industries it serves, including:
Columbia Gas Distribution
American Electric Power
Toyota Motor Manufacturing
Kentucky American Water
Various state, county and municipal public service districts.
Nitro Electric primarily services utility companies and municipalities.
ESOA overpaid for a pipeline company which it has since sold at a loss. In December of 2012, the company emerged from a forbearance agreement, and the company has executed nicely since then, with very high asset turnover >200%, growing EBITDA margins, and annual ROIs >20%.
Price to Tangible Book Value: 0.87
Price to FCF: 7x
TTM Dividend Yield: 3.6%
The dividend is new as of this year, and is higher than all of the profitable energy service comps I could find. These metrics all indicate an undervalued stock relative to the oil services industry as a whole.
Energy Industry Outlook
I am not an expert on oil or natural gas fields, which is why I prefer to buy an energy services company with significant utility and municipal exposure rather than a pure-play owner of well or pipeline assets. From the research I have done it seems that while energy prices will likely be lower than the past decade, we may be near the bottom of the industry trough. Marcellus/Utica specifically is established and has cheaper cost of production than other shale fields.
Over the past several years, companies operating within the U.S. energy sector, and in shale particularly, have continuously lowered operating costs. OPEC’s recent agreement could further bolster the industry.
ESOA is headed by Douglas Reynolds, the representative of District 17 in the West Virginia House of Delegates, and son of local Huntington business magnate Marshall T. Reynolds.
Since taking the helm at ESOA in December of 2012, Douglas Reynolds has increased tangible book value per share of the company from $0.43 to $1.43/share, a more than 3x increase. ESOA’s share price has grown by 150% over the past 4 years, vs the S&P500 at 50% and the Russell 2000 at 64%. The CEO has also been modestly buying the stock, and issued this letter to shareholders explaining why he felt shares were presently undervalued.
“I am extremely pleased with the improvements that have been made over the last four years with one exception: the under-valued price of our stock. In December of 2012, our stock value fluctuated wildly between $0.50 and $1.00 per share, and rightfully so, as we were under a forbearance agreement and were restructuring our balance sheet. On December 28, 2016, our last trade was at $1.38. This value represents less than the tangible book value per share of $1.58 at September 30, 2016. Our price to earnings ratio is 6.57 at December 28, 2016, and our backlog was $78.5 million at September 30, 2016 compared to $71.3 million at September 30, 2015. Members of the Board and management have been consistent insider buyers of the stock and hope that you will continue supporting us in what is poised to be a great fiscal year 2017.”
His father Marshall Reynolds also happens to be the chairman of ESOA and CEO of Champion Industries, a printing company which has not had a great couple of years, but keeps the lights on. Mr. Reynolds also sits on the boards of several banks financing the debt portion of ESOA’s capital.
Neither Douglas nor Marshall Reynolds appear to have significant experience in the energy services business. What they do both have is a significant personal stake. Insiders own >30% of the shares and Douglas Reynolds takes a modest salary around $100k/year. I would expect that both Doug and Marshall bring valuable Rolodexes to the business as well, both from local government and business connections. Additionally, they appear to be smart enough to leave the general management of both companies to experienced industry veterans.
“The two customers, Marathon Petroleum and EQT, represented 18.2% and 17.6% of revenues and 40.6% and 11.3% of receivables net of retention, respectively. The Company had two customers that exceeded 10.0% of revenues for the year ended September 30, 2015. These two customers, Marathon Petroleum and Rice Energy, represented 14.6% and 22.8% of revenues and 14.5% and 32.6% of receivables net of retention, respectively.”
In a sector as wild as energy, accounts receivable write-offs are one way to look for issues with customer payments. Rising write-offs indicate that customers cannot afford to pay their bills. A/R write-offs have been negligible for the past two years. The company wrote-off ~$11k in A/R in 2015, which increased slightly to $14k in 2016, on roughly $100m in revenue.
Days Sales Receivables is a metric which gauges credit risk from customers as well as project completion, with a lower number of days being better. Days Sales Receivables in the energy services industry ranges between 65-90 days for the largest energy services companies. We should expect a company this small to have higher DSR. Days Sales Receivables have declined slightly from 112 to 106 days for 2016 and are on-track to decline further in 2017 due to sizable project completions in 1Q17.
The biggest A/R customer currently, Marathon, is highly levered, but does not appear to be in danger of bankruptcy in the near-future. MRO bonds are trading at or around $100+, signaling that creditors are not worried about Marathon’s ability to pay its bills. I could not find much on MRO’s break-even cost in the areas which ESOA services, but according to this EQT is one of the lowest cost natural gas producers in the Marcellus field. EQT actually seems well-positioned to roll-up other operators, which could be a good thing for ESOA’s backlog. Marathon’s outlook seems a bit murkier, but neither EQT nor MRO show signs of serious financial distress.
All employees of CJ Hughes are union members, which means some collective bargaining risk is baked-in. In total, ESOA employs 920 people. I would expect some pressure on SG&A in the form of wages. Additionally the company contributes to a few multicompany pension funds which are currently underfunded. I could not find any indication that ESOA itself is not paying it’s allotted portion.
The company’s debt schedule shows $9.1m coming due in 2017, which could result in lower FCF compared to 2016. I expect some of the additional debt repayment to be offset by about $1m less in CAPEX; the company purchased a building which Nitro Electric had been leasing in early 2016. The 10-K also mentions that management expects to renew the current line of credit. Given the strong local banking ties and solid balance sheet, I would expect some revolver debt to be rolled over to 2018.
Outlook for 2017 and Beyond
Energy Services of America is well-positioned to benefit from any increase in energy or infrastructure investments in the Mid-Atlantic region. The company reported a backlog of $78.5m as of the end of September vs $71.3m in September of 2015. First quarter is typically when you can get a good idea of the expected annual revenue, but 10% higher y/y backlog sounds encouraging.
Year over year the company grew revenue by 25.8% in 2015, and 32.5% in 2016, while at the same time improving operating margins and asset turnover. These improvements occurred in-spite of a tough 2-year stretch for energy service companies due to the global collapse in oil prices. The company is trading slightly below net tangible book value, and looks cheap relative to cash flow and EBITDA, which are both under 5x. The company also maintains a modest debt/leverage ratio of 2x. I’m not betting on lower tax rates, but ESOA also pays a current effective tax rate >40%. Tax reform would be yuuuuge for this company.
While the company is not the sort to provide detailed guidance, I found the recent 10k management commentary to be interesting:
“We were awarded several major projects in fiscal year 2016 that will be completed in the first quarter of fiscal year 2017. We will need to replace those projects in fiscal year 2017, but we feel the opportunities we are already seeing and our strong relationships with our customers will allow us to do so.”
The atypical shareholders letter issued on January 4th, and recent insider purchases seem to indicate that management is confident that recent growth and operational trends will continue.
I like nano and micro-cap stocks lately for several reasons.
- They tend to be much harder for big investors to buy put meaningful cash into without significantly moving the share price.
- They generally don’t have the same tax expertise as Apple or GE, so they stand to benefit inordinately from lower tax rates.
- They are often under-followed and consequently mispriced.
Due to an incredibly small market capitalization, ESOA is a difficult company for institutional investors to buy at any scale. The company has shown impressive operation improvements and has strong growth prospects. I believe ESOA is undervalued relative to the business prospects and to peers. The business fundamentals warrant another 2-3x turns in EV/EBITDA, which would put the stock price above $2/share in the short-term. A nano-cap penny stock like this should continue to maintain a valuation discount relative to larger names, but I expect management to continue to return capital to shareholders or to achieve an eventual sale of the company. To me this stock seems like a good long-term buy-and-hold prospect.