A play on natural gas finds its way into the portfolio and I bid adieu to an old friend.
Enerflex – EFX.TSX
August 26, 2020
Share Price: $5.92
Number Of Shares: 89 678 845
Market Cap: $530 million
Enerflex is a Canadian company focused on providing equipment, expertise and services to the natural gas industry. Their business covers a wide spectrum from gas compression, processing and transportation to refrigeration, power generation and project engineering. Their engineering division helps design and build gas-fired power plants, gas processing stations, compression facilities and the like. Their service and rental divisions offer support and key equipment to industry players. They are also increasingly focused on building, owning and operating their own natural gas facilities to ensure a more stable base of recurring revenue.
Enerflex has been around for decades and has a long operating history behind it. They are well diversified both within the industry as well as geographically, with significant operations in some of the world’s most important gas producing regions including Canada, the US, South America, Africa, the Middle East and Australia.
They have been focusing the last few years on building up a more stable base of recurring revenue through their equipment rental activities and their self-owned and operated projects. The aim is to try to even out some of the nastier bumps in the road in this notoriously cyclical industry. This, together with a reasonably strong balance sheet, should stand them in good stead heading into one of the worst downturns this industry has faced.
In buying this company, my assumption is that natural gas still has an important role to play in our energy future. While renewable forms of energy are making great strides and will become an increasingly important part of the landscape, natural gas will continue to be an essential adjunct to these more variable sources of supply. Industry projections call for a continued growth in the worldwide demand for natural gas over the next few decades alongside growth in the renewables field. I see no obvious reason to disagree with this assessment.
Over the past 5 years, Enerflex has earned around $1.11 per share, on average. This is what I’m using to base my back of the envelope value calculation on. At the current price of $5.92, the company is trading at a p:e of 5.3 to those average earnings. The stock also trades comfortably below its tangible book value of $9 a share. Total net debt is sitting at around 4 times my average earnings estimate. I could wish for better, but in the current market, that level of debt makes it one of the more solid corporate citizens in the industry.
Put this together with a well-diversified suite of operations, a global footprint and a long track record of profitability behind it and I didn’t have to work too hard to convince myself to buy in to this idea.
The negatives should be obvious. The shale industry in the United States, where the company generates half of its revenue, is on death’s doorstep right now. Operators are massively slashing their capex budgets as they assess how to best deal with the demand fall-out from the coronavirus. Enerflex is not immune to these issues and saw its earnings fall to break-even in the most recent Q2. Looking forward, it is quite likely that these difficult conditions will persist for a number of quarters, producing more break-even results or possibly even a steady stream of red ink.
But that’s par for the course. You don’t get to pick up a company like this for 5 times earnings if everything is looking rosy. Longer term, I expect earnings to recover. They might not fully recover but at a p:e of 5, I don’t necessarily need them to to still turn a profit.
And there is always the enticing possibility that earnings will not only recover but will go on to hit new highs as the industry emerges from this downturn. The world’s insatiable thirst for energy has to be quenched somehow and relatively cleaner burning natural gas could be a good stop-gap solution. The new LNG terminal being built in Kitimat could eventually drive a renewed wave of exploration and production in Alberta, a renewed sense of restraint by the shale oil frackers in the US could finally put a floor under the price of natural gas, encouraging further development and an increasing shift from coal to gas around the world could provide a deep pool of future demand.
In a more company-specific vein, Enerflex has been focused on building out its fleet of compressor units that are not dependent on new exploration but instead are needed simply to serve existing production. Enerflex has added significantly to its fleet of rental equipment over the last 2 years. It has also been focusing on building and operating its own natural gas projects around the world and several of these are due to come on stream later this year, providing additional ongoing sources of revenue.
An eventual recovery in the gas industry, combined with continued growth at Enerflex and an expanding p:e multiple could well drive a multi-bagger over the next few years if the gods of fortune were to allow it.
Sold Magna International
Being as fully invested as I want to be at the moment, I needed to find something to sell to make way for Enerflex in the portfolio. After considering the options, I finally decided to part ways with my Magna. The share price of Magna has recovered nicely from the lows it hit just a few months ago and indeed, is now trading at pretty much the same price it was at before the wheels came off the economic bus.
At the current share price of $67 or so, the p:e, using last year’s earnings, is sitting around 10. Hardly nosebleed levels. The odd thing about Magna, though, is that this is one of those stocks that seems to always sport a perennially low p:e multiple. Looking back over 20 years, it’s rarely traded above this level even when the world was not experiencing a global pandemic. I can’t really see the logic in that and for several years now I have stubbornly held on to my Magna shares hoping that someday the market will see the error of its ways.
However, I decided to finally stop calling the market’s bluff. I’ll move from Magna to Enerflex, a company trading at a significantly lower p:e ratio and a third the price to book ratio. I’ll have to leave it to someone else to make their fortune on Magna.
Full Disclosure: I own shares in Enerflex. I do not own shares in Magna International.