http://seekingalpha.com/article/2422445-enterprise-group-offers-a-compelling-50minus-60-percent-upside?uprof=45

Summary

  • The company features strong growth prospects, gross margins approaching 50%, synergies between divisions, patent protected technology and fully funded capex budget.
  • Current share price of .91 cents Canadian translates to a forward p/e of just under 9, which is well under its peer group median forward p/e of 17.
  • Projected stock price of $1.30 to $1.50 is based on conservative assumptions and does not take into consideration potential near-term catalysts which could lead to a significantly greater upside.
  • Little future growth is currently priced into the stock making an attractive risk/reward dynamic.

The Company

Enterprise Group trades on the TSX under the symbol E, or [(OTC:ETOLF)] in the U.S. and is a Canadian energy, utility and infrastructure service provider operating chiefly in the province of Alberta.

All $ amounts mentioned are Canadian dollars.

Over the last several years, the company has executed a strategy to "acquire complementary service companies in Western Canada" and currently has 5 divisions in infrastructure, pipeline servicing, and equipment rental. The acquisitions were done at accretive valuations, paying around 3x EBITDA for profitable companies with existing track records. Near term, the company has a stated goal of bringing revenues up to $150 million from the 2013 of $35 million.

I believe that 2014 will be a year of organic growth which will highlight that a strong competitive advantage has been created through synergies between the divisions. The rest of this article will be laid out as follows:

  1. Give a brief overview of economic environment of the build-out happening in the oil sands and LNG infrastructure development currently underway in western Canada.
  2. Describe each division in more detail.
  3. Outline prospects for growth and show how their latest acquisition, Hart, will help create synergy within the company.
  4. Alert readers to certain risk factors.
  5. Provide a valuation range.

The Economic Environment

The company operates chiefly in Alberta, Canada, a province which is undergoing an intense build-out of its energy sector. Oil sands spending will rise from its 2012 level of $35 billion a year to about $52 billion per year by 2017. Both capex and maintenance spending is expected to be a cumulative $650 billion through to 2025 as total oil production is geared to ramp up from 1.8 million bbl/d to 4.5 million by 2025.

LNG investment has also surged and there are currently 6 permitted LNG facilities to be built on the west coast, with feedstock coming from Alberta, requiring 1000's of km of pipe.

Key among one of the many challenges facing this build-out, and one of Enterprise Group's opportunities, is the transportation challenge in being able to bring the oil and gas to market. Pipeline construction is not just between Alberta, the Canadian west coast and the United States, but within the province as well. There is an estimated 49 regional projects within Alberta requiring over $23 billion in investment within the next 3 years alone that are listed in the provincial government's Inventory of Major Projects.

Figure 1 Interprovincial/International Pipeline Proposals

Source: globalresourcenews.com

The build-out has lead to strong labour demand which has seen net migration to Alberta the strongest among Canadian provinces. Alberta's population growth rate is (2.5%) double that of Canada as a whole (1.1%). This population migration has led to even further infrastructural development within subdivisions in the municipal residential/commercial/retail space. Including telecom, utility, and other infrastructure, the province lists 410 projects totalling over $41 billion in combined construction investment slated for completion in the next 5 years.

The combined effect of this investment in energy and infrastructure is to make Alberta one of the world's top economies, with a full plate of construction projects over the next two decades.

Figure 2 Power/Telecomm/Infrastructure for Commercial/Retail/Residential. 410 Projects, $41.3 Billion within next 5 years

Source: Inventory of Major Projects, Alberta Canada

Source: company website.

Utility and Infrastructure

TC Backhoe

TC Backhoe has been operating for over 30 years, and has been the main source of revenue for Enterprise up until this year. It works primarily with underground (buried) infrastructure in the utility space, providing power line distribution, pipeline construction, directional drilling, utility construction and hydro-vac services. Such work includes installing, repairing and replacing power lines, street lighting, phone lines, and other buried infrastructure for developers, as well as site maintenance and clean-up services for utility owners. Its customer base includes some of Canada's largest providers of telecommunications, cable television, electricity and natural gas services.

TC Backhoe Drivers for growth

As the population of the province continues its growth in housing needs, TC Backhoe is seeing very heavy demand in this space and its business has been growing organically at 20% p.a. This division has less seasonality than other divisions which service the energy sector.

In addition to the ongoing residential and commercial build-out in the province, the primary drivers for growth with TC Backhoe will be the addition of 14 hydro-vac trucks this year (end of May the company had taken delivery of several trucks and had a total of 14 in its fleet). This will increase its fleet from 6 at the beginning of this year to 20 by the end of the year, and represents a fairly new line of business for TC Backhoe. Demand is currently upside down for capacity, with the pie growing so quickly that they have not yet come into direct competition from others in the hydro-vac servicing area.

Hydro-vac trucks cost $500 000 to build and generate revenues of about $750 000 a year each, so payback is very rapid. Long-term commitments have been signed with Trans-Canada Pipelines (30 months), Kinder Morgan (24 month) and Somerville (almost 2 years). Enterprise will continue to allocate capex to this area provided they have the long-term commitments, and have contracted an additional 12 units to be delivered over the course of 2015 to satisfy demand. The length of TC Backhoe's contracts provide good revenue visibility into the future.

Of Enterprise Group $35 million in 2013 revenue, TC Backhoe provided $27 million of that and had a net margin between 16-17%. The addition of the hydro-vac trucks should see revenue growth from TC Backhoe exceed 20% FY 2014 and increase net margins over 2013 levels. I am projecting $32 million in revenue from TC Backhoe.

Calgary Tunneling and Horizontal Augering (CTHA)

In June of 2013, Enterprise bought Calgary Tunneling and Horizontal Auguring ("CTHA") for $12 Million, which was just over 2x its 2012 EBITDA of $5.9 million. This means 2014 is the first full fiscal year in which these additional revenues will be felt. The company was founded in 1984 and is a leader in trenchless solutions, including laser guided boring and augering, pipe ramming, and pipe jacking/tunnel boring.

Current operations run all the way from the west coast through to central Canada across the energy, utility and infrastructure segments. The client base includes some of the country's largest railroads, utility providers, contractors and pipeline companies.

CTHA typically installs pipe from 12 to 72 inches and has completed a project at the Calgary airport which was 115 inches in diameter. The acquisition of this company helps combine the capabilities of TC Backhoe in traditional trenching, with a trenchless solution provider to round out corporate capabilities.

CTHA Growth Prospects are Excellent

Recognizing the strong demand and the need for additional capex, Enterprise recently floated an oversubscribed equity offering, raising over $27 million ($CAD). Management's original plan was to raise $12 million in the first year and $12 million the next. This would have provided a capex budget in 2014 of $20 million ($12 million allocated to Hart, Enterprise' newest addition).

Plans changed when the company was approached by a large engineering firm to discuss the possibility of a JV for tunneling, using CTHA. Preparation for the (possible) project required a $6.5 million investment for Enterprise to purchase a single piece of specialized tunneling equipment.

If you look at the maps of regional and interprovincial pipeline projects (above and below) you can begin to get an appreciation of the growth potential for this business-line. When a pipeline is being trenched and installed and comes to an obstacle like a road, highway, railway or river, then the pipe has to either go over or tunneling is needed to pass the line under. For long distance pipelines, this can mean 1000's of crossings.

The tunneling equipment being purchased allows for a new way to do crossings without using drilling fluids. This is important when it comes to crossing rivers. With environmental sensitivities impacting the energy sector, there may be prohibitions put in place on fracking and drilling fluids in use for river crossings. There is a risk of these fluids entering the water through cracks in the rock. The new machine can do the crossings without the need of fracking/drilling fluids. This is what is called micro-tunneling technology and Enterprise will the first company in Canada capable doing fluid free boring.

There should be more clarity on the possibility of a JV in August. This is an unknown, but potentially hugely important event for Enterprise. According to management, the types of crossings this equipment piece will be used for could generate $4-$15 million per project.

Even excluding the potential for a new JV, there is only one other competitor in the western region. This shows up in company margins with EBITDA margins of 45% and net margins of over 20% for this division.

With a long roster of future builds the organic growth outlook is outstanding for this division.

Since the company was acquired mid-way through last year, 2014 will be the first full year for the revenue impact from CTHA to be felt in Enterprise numbers. I am projecting $16 million in revenue to Enterprise from CTHA and net margins from this exceeding 20%.

Figure 3 PIPELINES Proposed/Announced/Under Construction - 49 Projects, $23.4 Billion within next 3 years.

Source: Inventory of Major Projects, Alberta Canada.

Figure 4 Tunnel Boring

Figure 5 Pipe Jacking

Figure 6 Tunnelling Pipe

Source: calgarytunnelling.com

Equipment Rentals

E-One

In Q1 2012 Enterprise launched E-One. E-One provides heavy equip rentals for oilfield and civil construction sectors. Due to seasonality, construction contractors will keep a core equipment base and rent out additional equipment when activity surpasses full utilization of their fleet.

E-One's equipment base is excavators, bulldozers, pipe-layers and operates in a highly competitive and fragmented industry. E-One competes with approximately 90 or more rental companies across the province and 4 regionally.

E-One offers no particular competitive advantage for Enterprise and is not expected to be a main driver of future revenues. Adding only about $2 million in revenue to the company, the management may simply decide to sell this off.

Artic Therm ("ATI")

Enterprise purchased Artic Therm Q3 2012 for $6.5 million, which was 2.4x trailing EBITDA. Established in 2000, the company provides flameless heating with very high outputs of up to 3.3 million BTUs from its large trucks.

This division needs a bit more explanation, particularly for readers who are not accustomed to the challenges of operating in cold weather conditions. Northern Alberta's climate offers some unique problems. Job sites are often in remote areas away from power-lines and are subject to extremely cold temperatures which can drop to -40F (and below).

In this environment, providing heat which does not emit harmful fumes (and is therefore breathable) and which is safe to operate around potentially combustible oil and gas facilities is a niche market. Machinery can, and does, freeze up. Plants shut down and restart. Applications include ground thawing, concrete curing, de-humidifying, fresh air circulation, flood clean up, and emergency heating.

Figure 7 Emergency Thawing with one of the smaller units

Figure 8 Plant Shutdown

Figure 9 Pipeline Thawing

Source: Company website

ATI Growth Prospects

Before Enterprise bought out Arctic Therm in 2012, the previous owners took the summer off and only stuck with the same 4 blue-chip clients. Enterprise has since taken ATI from a seasonal business to a 12 month revenue stream, has managed to triple its customer base and almost doubled the revenue out of this division in its first year. They have already doubled ATI's fleet and are seeing continued strong growth, with demand outstripping equipment.

Though still very seasonal, new applications are being discovered for their technology during the summer months.

One such application is their use in re-coating large storage tanks. To prevent corrosion, storage tanks are emptied, cleaned and re-coated. During the course of this work the interior of the tanks must be de-humidified, re-coated, then cured. The flameless heat provided by Artic Therm has proven to be an effective and safe way to do this.

2014 will start to see improvement in summer revenue from ATI, with 2015 expected to increase dramatically.

There is another aspect to this division which is unique and provides a very intriguing avenue for growth, and that is Thermal Pipe Expansion the larger trucks provide. The smaller units are not unique in themselves, but the larger trucks are exclusive.

The founder of ATI's original desire in starting the company was for the thermal expansion of pipelines. We're drilling deeper into the earth for fluids, and the deeper we drill the hotter the fluids. The hot fluids cause expansion of the pipe and can lead to leaks and cracks, particularly around risers or weak welds at joints. For every 1000 meters of pipe (3280 feet) it can stretch 1m (about 3 feet). Over a distance of 10 kilometers (6 miles), this can be significant. Breaches are a fact of life with long pipelines. By heating during the construction phase you can get the expansion out of the way before running hot fluids through the pipes and dropping the risk of pipeline breach. To date, pipes that have undergone pre-expansion by Artic Therm have not suffered any breach.

The trucks were specifically built for this and the technology is patent protected. Management is looking at the possibility of licensing out this technology to other areas of North America (the Balkan, Texas, Louisiana and up the Eastern seaboard). We may learn more about this, this fall.

Thermal pipe expansion during installation is still very much a market that is developing. ATI has been marketing this, and the new addition of Hart will help bring this greater visibility. At least 2 thermal pipe expansion contracts have been signed this summer.

This is a high margin business (net margins over 30%) with big growth potential and the technology is fully patent protected with 7 years remaining.

Revenue for 2014 from ATI was $5.9 million in 2013, but an unseasonably cold second quarter and the addition of summer usage could see revenue up 25% to $7.4 million and net margins over 31%.

Hart Oilfield Rentals

Dec 2013, Enterprise acquires HART for $22.6 million which was 3.1x trailing EBITDA. The deal was completed on January 3 2014, so 2013 sales did not include HART.

HART is marketed as a "one stop" oilfield service infrastructure company, servicing such oil and gas development plays as the Cardium, Duvernay, Montney and the Deep Basin. Hart has 5 locations to cover West and Central Alberta as well as a location in British Columbia (Pouce Coupe).

Equipment rented includes well-site trailers, sewage systems, power generators, fuel tanks, scaffoldings, potable water tanks, garbage/recycling facilities and fire suppression systems.

What really sets Hart apart from its competitors is its patent pending, modular/combo design in its equipment. The unique nature of these modular units allows for reduced time and labour costs for setup/deactivation as well as reduced transportation costs. This provides a large competitive advantage in an industry which often has to transport their infrastructure to remote sites, and makes Hart's equipment rentals more in demand than their peers.

The company also has teams of mechanics, plumbers, scaffolders, and service technicians in order to provide oil-field infrastructure set-up and respond in a more timely fashion to client needs.

Figure 10 Modular equipment

Hart's Growth Synergy Opportunity with ATI

Enterprise announced the signing of a 2 year master service agreement with Canada's largest natural gas producer earlier this year. The contract, $19.2 million over 2 years, is an increase over the previous contract, and Hart's largest contract to date. As the build out of the energy sector continues, utilization of equipment and demand should continue to grow from all of Hart's locations.

Hart owns about 2000 pieces of equipment, but needs 4000. In order to make up the shortfall, Hart rented out equipment from smaller local companies. This has acted as a drag on margins. Planned capex for Hart was $12 million for 2014, with $7.5 million slated to buy out the equipment types they had previously been renting. This will allow them to keep 100 cents on the dollar. It should be noted that Hart's net margin was just over 10% when Enterprise bought it out, and the replacement of these equipment pieces will have a meaningful impact in bringing that number up.

However, it is the synergy between Artic Therm and Hart that provides the most intriguing avenue for growth.

Before the addition of Hart, ATI was not a large enough player to command much attention. Hart, on the other hand, with its modular combo units and large footprint throughout Alberta is a recognized company. By replacing its heating units with those of Artic Therm, Hart can then showcase the technology of the larger trucks by dealing at the VP level of large companies like Encana and Shell, from the Regional Manager level Artic Therm was dealing with before. What Hart does for ATI is to bring greater awareness of the unique technology ATI owns right to the VP level among the large companies Hart already has relationships with.

The cross selling possibilities that Hart brings will impact TC Backhoe as well. Some of the projects that Hart works on use other hydro-vac operators as well, so management will be able to offer their own hydro-vac services to these projects going forward.

I estimate the addition of Hart should add a further $28 million to revenue for Enterprise over the 2013 revenue and $3 million in net income.

Other Growth Factors

Further acquisitions are probable. The management has been looking at a possible acquisition in Fort St. John, B.C. of another equipment rental company. Fort St. John has significant exposure to possible LNG pipeline builds as well as situated near the planned build of a $7 billion hydro dam. An acquisition in Fort St. John strengthens the company's reach to take advantage of another fast growing area in the neighbouring province of British Columbia. This would enable a further reach for all divisions of Enterprise.

Risk Factors

Micro-cap company

The price of oil and gas is the largest macro factor impacting the economy in the region Enterprise operates in. Investment in the industry can be influenced by global and governmental factors beyond the control of the company, and as we saw in 2009, can change rapidly.

Weather. Much of the business in is seasonal in nature. Much of the oil and gas economic activity occurs during the winter months when the ground is frozen and heavy equipment can traverse. During the spring and summer, what's referred to as the "spring breakup," the ground becomes wet and swampy in places and the province puts restrictions on the movement of heavy equipment.

This makes Q2 the company's weakest quarter, and an early spring or late/short winter can impact annual revenues by shortening the primary revenue season.

Competition. Equipment rental and infrastructure both have low barriers to entry. Much of the success of Enterprise will be the ability to maintain a competitive advantage. As the company grows, it will begin to come into direct competition with larger companies (for example, Badger Daylighting). Although the company currently enjoys patent protection in some divisions, the high margins are attractive to new entrants and current participants are expected to increase their overall capacity as well.

Customer concentration. In 2013, 56% of revenues came from the company's 10 largest customers, and the 2 year $19 million contract Hart signed is another indication that customer concentration is a risk.

The integration of company acquisitions, and the management of fast growth (including sourcing qualified employees) represent other possible risk factors.

Key employee risk. The company has signed agreements with the existing management of the companies it has recently acquired and relies heavily on their expertise. A loss of a key, or several key employees, could have a significant impact.

Dilution. This will be fairly significant. As it stands, for 2015 there is a strong likelihood of shares outstanding increasing 15% to around 165 million from the current 145 million base. The potential purchase with the equipment rental company in Fort St. John, B.C. may require additional dilution, depending on the purchase price and deal structure.

Valuation: Adding it all up

I am projecting 2014 revenues ($CAD) of about $83 million, up from $35 million in 2013 and EPS to be .105 cents/share and EBITDA of $27-28 million. This is slightly less than management guidance of $33 million EBITDA FY 2014 and .11 cents EPS from Thompson Reuters.

A multiple based valuation is most appropriate and I am using trailing P/E and EV/EBITDA multiples for several reasons: I am an individual investor and lack access to a database from which to source analyst estimates of forward EBITDA. I do not have the time to develop individual models for each of my comparable companies, though I did model Enterprise. Forward EPS estimates are readily available from over-the-counter sources, but to keep the multiples used consistent, I will use trailing EBITDA and trailing P/E as valuation metrics.

To determine valuation multiples I looked at two sources, a peer group and the industry group, and then used the most conservative numbers.

I determined a comparable group to be comprised of the following companies, all listed on the TSX under the symbols: ENT, BAD, WEQ, MCR, CFL, PRW, LSI, E.

 

Price

 

PE

 

EV/EBITDA

 

Forward EPS

 

Forward PE

ENT

$1.47

 

14.2

 

6.6

 

.08

 

18.4

BAD

$31.76

 

31.2

 

15.3

 

1.37

 

23.2

WEQ

$7.92

     

8.8

 

.24

 

33

MCR

$4.20

 

5.9

 

4

 

1.05

 

4

CFL

$3.76

 

16.9

 

7

 

.3

 

12.5

PRW

$1.23

 

28.9

 

6.6

 

.082

 

15

LSI

$3.23

 

728.3

 

36.5

 

.03

 

107.7

E

$.91

 

12.6

 

12.2

 

.106

 

8.6

Median

   

16.9

 

7.9

     

16.7

The second comparable group is composed of 52 companies comprising the Oilfield/Services Equip industry in Canada. For this group the median industry trailing EV/EBITDA is 7.5 times and trailing industry p/e multiple is 15.

 

EV/EBITDA

P/E

Peer Group

7.9

16.9

Oilfield Svcs/Equip

7.5

15.1

The more conservative multiples are the industry multiples, so they will be used in place of a more direct peer group.

EBITDA Multiple 7.5

Projected EBITDA $27600

EV (7.5*27600) $207004.84

Less: Debt $42270.8

Less: Warrants $4022.4

Add: Cash $25503.9

Equity Value $186215.5

Shares Outstanding 145467

Share Value $1.28

P/E Multiple 15

Projected EPS $.105

Share Value $1.57

Base Case Scenario

$1.30-$1.50

This represents my baseline assumptions.

Optimistic Case Scenario

$1.65-$2.11

On additional revenues from CTHA in Q4 for JV, and revenues from hydro-vac trucks that were not taken into consideration to establish my baseline. Total revenues to $99 million, EBITDA $35 million and EPS 14.1 cents using EV/EBITDA 7.5 and P/E 15.

Poor Case Scenario

$.85-$1

Based on revenues $73 million, EBITDA $24 million and EPS 8.5 cents, and a multiple reduction to EV/EBITDA 6.0 and P/E 12

The poor case scenario points to an interesting skew in the risk/reward offered at these prices, so I will look at one other metric, the PVGO that are currently "priced into" the stock.

PVGO

Another metric I'll look at is the present value of growth opportunities (PVGO) that are currently priced into the stock. While this will not give you a price target, it can provide some useful information in gauging value and risk relative to a company's peers.

Essentially, it is a rough guide in determining how much of a company's current share price is based on expectations of future growth and how much is the value assuming zero growth. A zero growth value is priced as a perpetuity (forward EPS divided by an appropriate discount rate). This is then subtracted by the current stock price to arrive at a growth component.

If a larger component of the current stock price reflects future growth, then it may mean there is additional risk in the price if that growth fails to materialize.

To determine the discount rate (always a contentious issue) I made the following assumptions:

Risk free rate of 3%

Market risk premium of 5.5%

Small cap premium of 4% below $1 billion market cap and 2% between $1-2 billion market cap (for BAD).

I ignored beta, as most of the comparable companies used have a beta of less than one and I do not consider small cap companies to carry less than market risk.

Using the 12.5% discount rate, and pricing the forward EPS (using analyst estimates) as a perpetuity, you can see that future growth represents only .07 cents of the current .91 cent stock price. Less than 8% of Enterprise value is composed of growth expectations. With less future growth priced into the stock than its peer group, Enterprise just might hold less risk to the downside and make for a more attractive comparable offering.

The growth expectations I have for this stock do not seem to be priced in, and offers an opportunity for a skewed risk/reward investment.

   

EPS1

Discount

Perpetuity Value

(EPS1/discount)

PVGO

(current price - perpetuity)

% of stock price represented by future growth

ENT

$1.47

$0.08

12.50%

$0.64

$0.83

56.46%

BAD

$31.76

$1.37

10.00%

$13.70

$18.06

56.86%

WEQ

$7.92

$0.24

12.50%

$1.92

$6.00

75.76%

MCR

$4.20

$1.05

12.50%

$8.40

-$4.20

-100.00%

CFL

$3.76

$0.30

12.50%

$2.40

$1.36

36.17%

PRW

$1.23

$0.08

12.50%

$0.66

$0.57

46.67%

LSI

$3.23

$0.03

12.50%

$0.24

$2.99

92.57%

E

$0.91

$0.105

12.50%

$0.84

$0.07

7.69%

The only other company not priced for growth is MCR, which looks like it's expected to destroy value. Perhaps I'll look into that in the future.

Enterprise Group is a profitable company with some exceptionally high margin business lines positioned in a rapidly growing economy, with business growth prospects not currently priced into the stock. I believe the risk/reward dynamics currently favour the investor.

Disclosure: I own shares in Enterprise Group.

Disclaimer: This is my first posting about any company, and I did this primarily to help hold myself accountable for my own investment decisions and provide a means of looking back to the inputs I used to make my decision. I am not making an investment recommendation.

Constructive feedback would be appreciated, as I am accustomed to building portfolios using index and mutual funds and not individual stocks.

Please do your own research before coming to an investment decision.