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Fracking Liquids and Solid Dividends

October 22, 2012 | About:
Energy services is an extremely cyclical and highly competitive business that requires companies to be effective deployers of technology, savvy financial managers and opportunistic salesmen of their wares and services. And even companies that do all three tasks well can fail if they’re caught leaning the wrong way when industry conditions turn down.

That was the case for several Canadian services companies in 2008, when oil prices fell from a high of USD150 a barrel to barely USD30 in a matter of a few weeks.

It’s been the case for others the past couple years, as crashing natural gas prices brought the North American shale gas drilling boom to a screeching halt.

Energy services companies’ profits and therefore dividends are leveraged to energy prices in two ways.

First, when energy prices rise demand for their services and equipment does too, increasing utilization rates and sales.

And companies can also charge more for both, giving profits a further kick. Conversely, when energy prices drop demand for services and equipment slumps, and fees providers can charge do too.

Poseidon Concepts Corp (TSX:PSN)(OTC:POOSF) has managed to dodge the worst of the past few years’ downturns by locking in its customers to longer-term contracts as well as by expanding outside Canada. Poseidon’s primary niche of handling fracturing fluid has proven sturdy, as it relies far less on new drilling than several other energy service providers do.

Not even unseasonably wet weather was able to hold back Poseidon’s second-quarter growth. In fact the company actually reported better numbers in every key area over the first quarter of 2012, despite a 38 percent year-over-year decline in western Canada well completion activity.

The key was an expanded share of a niche that’s growing rapidly. Poseidon utilizes storage tanks to help producers manage the water used for hydraulic fracturing, or “fracking,” the process now used to develop the vast majority of energy wells in North America.

Its process has a far less pronounced impact on the surrounding environment than the currently widely used strategy of using “lined pits” to store water. And tanks can be moved from well to well as needed.

Poseidon’s customers wind up renting multiple tanks to perform simultaneous well completions as well for the longer-term purpose of storing fluids in a central location to be re-used on successive wells. As a result they tend to generate a great deal of repeat business, which makes for stable cash flows even when new drilling is largely on hold.

The company currently has operations across Canada and in 19 US states, with a particular focus on capturing business in oil and liquids-rich basins. That puts it squarely in line to benefit from the expected doubling of US oil production by 2035, which is now forecast by US Energy Information Administration.

It’s also benefiting from the backlash against fracking in general. For example, North Dakota--hardly a tree-hugging, “blue” state--banned the use of lined pits as of April 2012. That’s forced developers of its prolific Bakken Shale reserves to seek alternatives for water treatment. And here too Poseidon comes out on top, as its modular tanks are far most cost effective than the 400- and 500-barrel steel tanks used for decades by industry.

Most exciting, the company currently has only a small portion of the fluid handling market, so there’s massive upside on both sides of the border.

And because it fundamentally operates a rental business, it has low fixed costs and generates a hefty level of free cash flow.

Poor drilling conditions may slow the adoption of its technology and services, and thus sales growth.

Management’s outlook issued last month was for its growth in western Canada to be challenged by this, though more than made up for by US growth.

And meanwhile, “revenue visibility” is high due to the high proportion on long-term contracts with large, well-hedged energy producers.

The full-year 2012 forecast is for cash flow of CAD210 million, based mainly on the continued growth of the tank fleet.

That equates to roughly CAD170 million of after-tax cash flow and comfortable coverage of both CAD87 million in dividends and CAD60 million in planned capital expenditures for the year.

With debt modest at 27.6 percent of assets (and nothing due before 2014), that’s a considerable cushion against unexpected loss of business, even as the company continues to lay the groundwork for long-run growth. And though management has yet to declare its intentions, it’s also a firm foundation for future dividend growth. I profile three more Canadian dividend stocks in my free report.

About the author:

Roger Conrad
Investing Daily provides stock market advice and investment newsletters to help independent investors achieve a secure and rewarding financial future. The site’s coverage focuses on finding the most profitable emerging trends in the investment universe to bring investors pragmatic and in-depth coverage of the names that are taking advantage of these opportunities.

Visit Roger Conrad's Website


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