The last time I recommended T-3 Energy Services (NASDAQ: TTES ) to the subscribers of my investment letter, Capital & Crisis, the stock tripled over the ensuing months. And even after I issued a “Sell” recommendation on the stock, it continued to move higher. But that was WAY back in July…and nothing is like it used to be.
From a high of $84 a share in July of this year, the stock has come all the way back down to $17. I issued a “Buy” on the stock in April of 2007, when it was selling for $21.60. We sold our final half at $63.60 — it’s now more than 70% below that price. And you know what? Not much has really changed…except the stock’s valuation. TTES is selling for about 6 times earnings now and about 5 times next year’s guess…and the company is enjoying huge macro-economic tailwinds.
T-3 makes something absolutely critical to drilling rigs. It’s called a blowout preventer (BOP). BOPs protect the crew — and preserve the rig — in the event of surges in the well. You absolutely have to them. Crews won’t work rigs without BOPs and anybody concerned about safety would never put a crew on a rig without them.
T-3 has about 15% of the market for new BOPs. If you count refurbishing older rigs, T-3 has about 30% of the market. It’s a small company, but a key player in this niche. BOPs make up about 70% of T-3’s business.
The remaining 30% includes a variety of other services for wellhead equipment and onshore pipelines. T-3’s customers are drilling contractors, exploration and production companies and pipeline companies.
Demand for T-3’s services follows drilling activity. Over the years, we’ve had to drill more and more gas wells, just to maintain current levels of production. That’s because the newer wells tend to deplete much more quickly that the old wells used to.
That trend has only continued. According to Baker Hughes, the number of working rigs rose to 1,782 at the end of 2007 to 1,906 today. As we exploit the more unconventional shale basins, which are more drilling intensive, the number of working rigs ought to keep rising.
The shale plays I’ve written about before – the Barnett, Fayetteville and in the Appalachian regions – all take a lot of drilling. Since 2001, for example, drilling in the Barnett is up nine-fold by rig count. These prolific plays now make up 12% of the total rig count according to Raymond James.
Drilling activity is what really drives T-3’s business. And energy prices dictate drilling activity. So, as the price of oil and gas has come down a bunch, the market has crushed T-3’s stock price. I think, though, that it’s been overdone. Drilling activity may slow, but we’re not rolling back to 2002 levels, which is how the market is pricing T-3.
I also especially like the rig equipment and infrastructure market. Since 2004, this market has grown 27% annually, which tops the broader oilfield services group. (The latter grew about 17% annually.) T-3 serves a good niche in this sub-market.
The company is also expanding overseas. Already 60% of the company’s sales come from overseas markets. New orders from West Africa and Russia, new subsea orders and new orders from its joint venture in the Middle East could all be catalysts for the stock price beyond just solid execution of its existing business. Earlier this year, T-3 won a contract for work in West Africa, which was the biggest single award in the company’s history. As of the last conference call, T-3 said it had $320 million in outstanding bids and 60% of that was for international markets.
Last quarter, the company reported a backlog of $81 million, a 36% increase from the prior quarter and a 31% increase from a year ago. T-3 should grow earnings at a 25% clip, yet it’s trading for 7 times earnings. You got a lot of room for error when you buy something for 7 times earnings that’s growing 25% per year.
T-3 will probably earn $40 million in free cash flow this year. Next year, the company should generate $50 million in free cash flow and earn close to $4 per share. At current prices, therefore, you’re paying less than 5 times next year’s guess for a 21% free cash flow yield. Those are bargain numbers for a healthy, growing business with little debt.
Another way to look at the stock’s value is to look at past acquisitions. Last year, acquirers paid 11 times EBITDA (earnings before interest, taxes, depreciation and amortization) for companies in this sector. Even this year, if you could pull off an acquisition at 8 times EBITDA in this sector, you were a hero. Analysts would praise you for making a good deal. Now the sector is in the toilet. T-3 trades for a bit more than 4 times EBITDA. So again, there seems to be plenty of room on the value spectrum here. The world did not change so much in the last 90 days as stock market prices seem to indicate.
Right now, multiples across the resource sector have just collapsed. If T-3 were to regain a reasonable multiple of only 10 times earnings — well below what it commanded even months ago — T-3 could be a $40 stock by next year. That’s more than double.
If we get some more juice from oil and gas prices, we could go much higher. Some of the research I’ve read on the company puts the value much higher, in the range of $72 to $90 per share. Remember, the stock hit $84 this year. So, I think my numbers are quite reasonable. We’ve got a good shot to do a lot better than $48 per share, perhaps getting back to around $60 and tripling our money again.
I’d buy the stock up to $25 a share.
$20.09 (10/30/08)
