Although oil prices are back in the triple digits, energy investors are not exactly resting easy these days. Not only are investors worried about the extent to which E&P and service companies can shift from gas to oil, but also the potential impact of higher costs on forward margins and returns. While Basic Energy Services (NYSE:BAS) is not a perfect company, it seems to be trading too cheaply relative to its business prospects and financials.
Investopedia Markets: Explore the best one-stop source for financial news, quotes and insights.
Sluggish Performance to Close the Year
To be sure, Basic Energy did not make the best case that it's a must-own stock on the basis of its fourth quarter performance. Revenue was up just 2% on a sequential basis, coming in as analysts expected, but offering less domestic growth (and BAS is a U.S.-only story) than major energy service companies like Halliburton (NYSE:HAL), Baker Hughes (NYSE:BHI) and Weatherford (NYSE:WFT). (For related reading, see Peak Oil: What To Do When The Wells Run Dry.)
Basic Energy saw flat performance in the well servicing business, but 4% growth in fluids and 2% growth in its large completion/remediation business.
Margins were more problematic. Not to beat the point to death, but the company trailed its larger peers in this regard as well, as gross margin edged down slightly and EBITDA came in flat for the quarter (slightly disappointing relative to expectations). The reasons for this flat performance are cogent (namely, pressures from seasonal cost increases), but Wall Street rarely cares as much about the "why" as the "what."
Right Place, Right Time?
At least on a superficial basis, it would seem that Basic Energy should be the right sort of company for the present energy environment. Oil and liquids presently makes up about 70% of the company's revenue base and management should have relatively little trouble moving assets from gas-focused areas in Texas, Louisiana and Arkansas to the oil-focused regions nearby. Likewise, the company has relatively little activity in gas-heavy areas like the Appalachians and Rocky Mountains.
Going further, about 80% of its frac business is leveraged towards oil. Also, oil wells tend to require more servicing and remediation services than gas wells, so the switch to more oil-intensive drilling should fit into their playbook. Keep in mind, too, that this is the third-largest servicing fleet in the U.S., so they'll get their share of business alongside Key Energy (NYSE:KEG) and Nabors (NYSE:NBR).
The Bear Side of the Story
So, what could go wrong with the Basic Energy story?
For starters, the company carries a lot of debt and is yet quite active in acquiring small competitors and assets like rigs and trucks. Basic Energy is also completely focused on U.S. onshore drilling activity, and there are concerns that this is at or near a peak. Last and not least, while Basic Energy is leveraged toward oil, it's not much of a factor in the Bakken - one of the most exciting areas in U.S. energy today.
More basic issues and concerns can come into play as well. Should oil prices drop, that would put most energy companies in a tough spot, as natural gas prices are already weak. Likewise, Basic Energy needs to prove that it can deliver the sort of margins and returns on assets that suggest it's a real player for the long haul.
The Bottom Line
Although Basic Energy has outperformed energy service peers in general (as measured by the SPDR S&P Oil & Gas Equipment & Services ETF (NYSE:XES) over the past year), the stock has underperformed in the last six months. While I understand investor worries about margins and its lack of geographical diversification, the degree of its valuation discount still surprises me.
Basic Energy Services has carried a higher forward EV/EBITDA in the past, but even granting it a multiple of six times on 2012 estimated EBITDA suggests meaningful undervaluation, as the stock is presently trading for less than four times the average sell-side estimate for 2012. That sort of valuation gap should make investors re-examine their assumptions and dig a little harder for the bad news, but it may be the case that Basic Energy is a seriously overlooked U.S. energy services story. (For related reading, see Oil: A Big Investment With Big Tax Breaks.)
Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!
At the time of writing, Stephen Simpson did not own shares in any of the companies mentioned in this article.