Select Energy Services Stock: Still A Buy (NYSE:WTTR)

Beautiful transparent drop of water on smooth surface in dark blue colors.

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Introduction

Select Energy Services, Inc. (NYSE:WTTR) stock hasn’t moved much the last four months, a time when many of the OFS names have doubled. This is an oddity, as if the frackers like Liberty Energy (LBRT) are going to double, and the sand suppliers like U.S. Silica Holdings (SLCA) do the same, why hasn’t WTTR done better?

Now in fairness the two companies I cited as exemplars of out-performance have fallen 15-20% on valuation downgrades, and weakness in oil prices. In that light, WTTR’s performance, having touched $10 in March shortly after my last article, doesn’t look quite so bad. In that article I suggested that the company should be trading at $15.00, and it hasn’t gotten near that level. So, I will have to take an “aw-heck” for that outcome.

I still maintain that there are a lot of generally positive things happening for WTTR:

  • Share count reduction;
  • Growth (rapid) in core water recycling business (driven in part by increased seismicity in the Permian);
  • Growth in chemicals business;
  • Growth in broader frac market;
  • Increasing margins across all business lines.

All the that considered, I am maintaining my buy recommendation, and will update a price target for the company. Analysts agree with me that the company should be trading higher with a range of $7.92 on the low side, a median of $11.50, and a high target of $12.00. That gives us some to shoot for and we will see if we can get to the upper end of that range, or perhaps extend it a bit.

The thesis for WTTR

As I have noted, you can’t frac without water-except in special circumstances, which I’m not going to get into in this report. Production is increasing, rigs are higher, frac spreads are higher, and you can multiply by 10-12 mm gallons per well the amount of water needed. It’s a big business.

Most of the shale basins-Permian, DJ, Eagle Ford, Bakken are dry, desert-like environments without much surface water. That means water must come from aquifers that many rely upon for drinking water, so you can see the conflicts and concerns that have emerged. Pumping fresh water into oil reservoirs is just nuts – seriously nuts – and no one does it. What’s done instead is to add salts (KCL 3-5% wt/wt) to inhibit reservoir clays. When you add salts, the water is no longer fresh, and would have to go through reverse osmosis filtration to be removed, and perhaps even further distillation to get that fresh “taste.” Using fresh water in these volumes is unsustainable in a world where water supplies are under increasing demand.

Fortunately, the industry has adapted by learning to recycle brackish-salty water that has been flowed back from previous jobs or is produced water from existing wells for about 90% of their needs. This is timely for a lot of reasons because, as I noted above, there is increasing seismicity in areas that are unused to earth quakes.

As I said above, it’s a big business. Rystad notes that seismic problem are helping drive a surge in growth for water treatment companies.

“The oilfield water market is poised for a very interesting 2022. M&A activity, regulatory responses to induced seismicity, and rising produced water volumes across the US lower 48 states have all set the stage in 2021 for what will certainly be the most dynamic market conditions in a growing oilfield segment,” says Ryan Hassler, senior analyst with Rystad Energy.

Source

It’s a problem that threatens to put a cap on production – as if we needed another reason not to drill more and creates a rapidly expanding market for WTTR’s skill set. Nick Swyka, CFO comments in regard to operator appetite for recycling-

We are seeing that, so the recycling facility we announced in Lea County in Mexico was with an operator that we’ve worked for in the past and have another recycling facility with. And so they had a good experience with the first one. They wanted to make sure they could secure the disposal solution, as well as a produced water solution for their completions. And so it was a rent and repeat system. I think we’re going to continue to see more opportunities with our existing operator base.

Source

As I’ve noted in recent articles on WTTR, the company has made several key acquisitions that were complementary to current operations. They have a solid balance sheet and growing book of business. In an environment where the macro picture is as strong as it is now, they should be in a position to generate a lot of free cash. If this pans out the stock price should rise accordingly.

The company also participates in the oilfield chemicals space, and as I noted in the prior article, made an acquisition – Complete Energy Services, to facilitate that business. This deal brought trained personnel, a premium these days, and an increased footprint in shale plays where they were marginal players. Production chemistry plays into the company’s strengths, and there is a lot of synergy that comes with the merger. John Schmitz, CEO, comments on the synergy around water chemistry and the Complete Energy Services acquisition:

Once you put these asset bases together, they really complement each other in a meaningful way when you think about what they can do and be used for. The industry has converted from fresh to produced water, if you will, the water has gotten dirtier and chemistry is very important when you apply it to make that water source usable, as well as chemistry is very important when you actually use the water and the frac process being a dirtier water solution is chemistry.

Source

Select Energy Services Q1 2022 Results

Revenue for the first quarter of 2022 was $294.8 million as compared to $255.1 million in the fourth quarter of 2021. Net income for the first quarter of 2022 was $8.0 million as compared to $11.2 million in the fourth quarter of 2021.

Total gross margin was 8.4% in the first quarter of 2022 as compared to 7.0% in the fourth quarter of 2021 and (3.1)% in the first quarter of 2021. Gross margin before depreciation and amortization (“D&A”) for the first quarter of 2022 was 17.4% as compared to 16.6% for the fourth quarter of 2021 and 12.0% for the first quarter of 2021.

Adjusted EBITDA was $32.2 million in the first quarter of 2022 as compared to $26.4 million in the fourth quarter of 2021 and $0.9 million in the first quarter of 2021. Adjusted EBITDA was negatively impacted by the deduction of $11.4 million of non-recurring bargain purchase price gains that benefited Net Income during the quarter related to our recent acquisition activity.

The Water Services segment generated revenues of $163.6 million in the first quarter of 2022 as compared to $140.7 million in the fourth quarter of 2021 and $64.2 million in the first quarter of 2021. Gross margin before D&A for Water Services was 16.2% in the first quarter of 2022 as compared to 15.4% in the fourth quarter of 2021.

The Water Infrastructure segment generated revenues of $58.6 million in the first quarter of 2022 as compared to $46.9 million in the fourth quarter of 2021 and $37.8 million in the first quarter of 2021. Gross margin before D&A for Water Infrastructure was 24.2% in the first quarter of 2022 as compared to 25.8% in the fourth quarter of 2021.

The Oilfield Chemicals segment generated revenues of $72.6 million in the first quarter of 2022 as compared to $67.5 million in the fourth quarter of 2021 and $41.7 million in the first quarter of 2021. Gross margin before D&A for Oilfield Chemicals was 14.4% in the first quarter of 2022 as compared to 12.6% in the fourth quarter of 2021.

Cash flow from operations for the first quarter of 2022 was ($18.6) million as compared to ($2.4) million in the fourth quarter of 2021 and ($3.9) million in the first quarter of 2021. Cash flow from operations during the first quarter of 2022 was significantly impacted by a $44.9 million use of cash to fund working capital needs of the business, including the settlement of acquired Nuverra liabilities.

Net capital expenditures for the first quarter of 2022 were $3.3 million, comprised of $15.5 million of capital expenditures, largely offset by $12.1 million of cash proceeds from asset sales.

Total cash and cash equivalents were $24.8 million as of March 31, 2022 as compared to $85.8 million as of December 31, 2021. The Company had no borrowings outstanding under its sustainability-linked credit facility as of March 31, 2022 and no borrowings under its previous credit facility as of December 31, 2021.

Total liquidity was $213.3 million as of March 31, 2022, as compared to $202.9 million as of December 31, 2021. The Company had 91,821,906 weighted average Class A shares outstanding and 16,221,101 weighted average Class B shares outstanding during the first quarter of 2022.

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Catalysts for Select

The recycling centers are the wave of the future for water treatment. There is a lot of room for growth in the water-cut heavy Permian basin. There are ESG and regulatory drivers there that will drive growth. This will extend to other basins. Schmitz comments-

We do think that the lessons learned in the Permian that we’ve implemented and others on recycling are going to be applied to other basins, they just haven’t fully transformed yet.

Source

The recycling centers also make clients more sticky. When you hard pipe a line to take wastewater from collections centers, you do it under contract. These are usually long-term situations. The growth in this business will smooth revenue flows and provide numerous add-on sales opportunities.

Consolidation of prior acquisitions is the company’s focus going forward. Integration of Nuverra cost on the order of $50 mm in Q-1. That’s fine, Nuverra brought access to a new market-the Haynesville, but you can only chew so much at one time. An analyst pitched this question, and management addressed thusly-

Our focus for these coming quarters here is really on integration and bringing the value out, improving the margins and driving value and the operations.

Source

Risks

I think WTTR is de-risked at current prices. That doesn’t mean they are going higher, but I don’t see a lot of downside for anyone taking a position, absent the Fed put. We saw an example of that today. I see that as a tempest in a teapot, that will pass as demand continues to increase.

Another risk is the low barrier to entry. Select really has no technology moat-except the recycling centers and drives business with price and service. There are a zillion water companies and all use much the same technology. That means there’s two ways to grow:

  1. You take business with price.
  2. You buy market share with acquisitions.

Both are expensive.

Your takeaway

Not everyone agrees with me, but I think there is a strong driver that will push OFS companies higher. Increasing activity, we have that. Increasing profitability, we have that. Sure, there’s inflation, but to a large extent the OFS companies pass that along.

They tell us the acquisition and integration expense that have burned up cash over the last year are behind them, and the focus now will be improving margins.

WTTR bought $16 mm worth of their stock back in Q-1 and has $25 mm remaining in authorization. I expect they will jump all over this with the prices where they are. That would take another 3-4 mm shares out of circulation. Eventually this alone will boost the value of the stock.

Last time around we used a price to sales ratio to put a target price on the company. It was <1. It’s still less than 1. With a capitalization of $971 mm and one year run rate revenue of $1.2 bn the ratio is .8, which puts them well ahead of the sector median of 1.87. If we used that same 2X multiple the company is a double from present levels.

We have to pick and choose where we allocate our money. I think that with the water companies – this one in particular – that have lagged behind the rest of the OFS sector, then sector growth should deliver some the metrics we’ve looked at.

We think WTTR is a buy at current levels for investors wishing to participate in a key element of frac services.

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