NOA’s Short and Long-Term Drivers Are Keeping Busy

North American Energy Partners (NOA) provides mining and heavy construction services to the energy and industrial construction customers, primarily within Western Canada. The robust long-term drivers and the improving short-term drivers make a strong case to add the stock to your portfolio. The company has recently secured long term agreements with four major customers. Earlier, during Q4 2018, it added to its construction and mining assets through acquisitions. Although the current slowdown in Canadian energy market activity can disrupt its growth prospect, there are positive signs coming out of new construction projects. The production efforts at various mine sites are up, too. Its anticipated backlog growth has been substantial over the past couple of quarters, which signals higher revenue visibility.

The Long-Term Drivers

NOA’s customers are primarily the oil sands producers and conventional oil and gas producers. The company derives the majority of revenues from work linked to oil sands production, which is typically resilient to oil price falls. Over the years, NOA has built long-term relationships with major oil sands producers, including Syncrude and Suncor. In November 2018, the company entered into a partnership to provide construction and mining services to oil sands customers with Mikisew Group of Companies. In December, NOA extended its key contract three-year with a significant oil sands operator by three years. In December 2018, the company acquired thirty-one ultra-class haul trucks. Approximately 18 of these trucks are scheduled to be delivered in 2019. Recently, NOA has opened a new shop and maintenance facility for an internal project. The new facility will augment NOA’s external maintenance services capability.

Rig Count

By the end of Q1 2019, the rig count in Canda increased by 26%, while the U.S. rig count decreased by 7% during the same period. Year-over-year, however, the Canadian rig count declined by 34%. Much of the weakness in the upstream exploration and production stemmed from the volatility in the crude oil price.

On average, the West Texas Intermediate (or WTI) crude oil price decreased by 7.5% in Q1 compared to a quarter ago. Many of the energy producers have revealed their intention of cutting the E&P budget for 2019.

Analyzing Recent Performance

Given the deterioration in the indicators and a general downturn in the sentient, NOA’s Q1 2019 performance was no less than stellar. While its top line increased by 63% year-over-year and 42% quarter-over-quarter, its reported earnings more than doubled compared to Q4 2018. As a result of the fleet acquired in Q4, the company’s activity increased in the Fort Hills and Aurora mines as well as at the Millennium mine.

On top of that, volume growth was substantial in the Kearl mine, too. While revenues from Operations Support Services increased by 78% year-over-year in Q1, revenues from Construction Services declined by 29% during this period.

According to the data provided by Trading Economics, the crude oil production in Canada increased by 2.5% in February compared to January, although in both these months the production was significantly lower than the Q4-average. So crude oil production was less affected during the quarter, although exploration and new production activity reduced.

Headwinds

On the other hand, performance growth was negatively affected by adverse weather related to the Canadian spring-break, due to which the company lost volume of in-field repairs and maintenance work. Earlier-than-expected winter led to a revenue loss of $20 million. On top of that, low pricing in a couple of legacy contracts and poor condition of the acquired equipment on the site provided a headwind to the growth and caused earnings to decline compared to a year ago.

The gross profit margin also decreased in Q1 versus the gross margin a quarter ago, as the adverse of the legacy contracts took its toll on the pricing. However, the larger of these contracts are scheduled to expire in Q3, and given the recent trend, the new deal is expected to be priced higher, leading to a higher margin for the company.

Anticipated Backlog Growth Is Substantial

The most significant improvement was witnessed in NOA’s backlog. As of March 31, the backlog stood at ~$1.5 billion, up from a mere $0.1 billion a year ago. With increased customer inquiry, it seems upstream activity is recovering. Before the new contracts are signed, the company expects some additional backlog to be added. Despite such strong growth in backlog, the revenue realization out of the backlog has been moderating over the past few quarters. While the anticipated backlog increased by 320% since Q2 2018, only 9% converted into revenues in Q1 compared to 13% in Q2 2018. Indeed, most of the rise in the anticipated backlog was due to the tremendous surge in the undefined committed volumes. So it will be difficult to predict the extent of revenue generation from the growth, although we can generally deduce that a higher backlog will increase the revenue visibility in the coming quarters.

What Are The New Projects?

Looking at the growth prospect in the incremental earthworks and construction work, the company banks more on the organic core sand model. However, the company will balance its need for growth capital expenditure with its goal to de-leverage the balance sheet between 2019 and 2021. Its FY2019 capex plan of $130 million would be 60% higher than a year ago, because of some heavy projects during the year. In another exciting development, it is bidding on multiple precious gem and metal mine projects in northern Canada.

Dealing more on the new projects, the company expects its revenues from mining and heavy construction services to recover after the 2014 downturn. In 2019, the large construction work includes the Mildred Lake expansion project, which should start to benefit the company from 2020. The project, which belongs to Syncrude, will sustain the production of high-quality crude oil and is expected to commence production around 2023-2024. Apart from that, there are many smaller construction projects, including the small projects at Fort Hills. In construction, it focuses on large earthworks projects including flood diversion, road building, while also undertaking development & civil earthworks construction for greenfield and expanding sites.

Dividend Yield

North American Construction Group’s annual cash dividend is CAD 0.08 per share, which means a forward annual dividend yield of 0.58%. In the past year, its dividend has been steady.

Cash Flow And Capex

In Q1 2019, NOA generated CAD 47.5 million in cash flow from operations (or CFO), which was an improvement over the prior year. The higher CFO reflects higher revenues and improvement in working capital. NOA plans to de-lever its balance sheet by CAD $150 million, or by 57%, over the next three years, led by the expected improvement in cash flows.

In FY2019, NOA expects annual sustaining capital expenditures to be CAD 75.0 million to CAD 85 million. It also plans to spend CAD 15 million to CAD 25 million in growth capex. However, the capex may increase in FY2019 because of huge fund necessary to refurbish the relatively poor condition of the acquired assets. In comparison, in FY2018, the company spent CAD 81 million in capex.

Leverage Is High

NOA had CAD 20.4 million in cash and cash equivalents balance on March 31, 2019. It had CAD 177.5 million of liquidity available from its revolving credit facility as of that date. Following the acquisitions in Q4 2018, total debt increased by 179% in FY2018 and further 5.4% until Q1 019. The majority of debt repayment would be due in 2021 (CAD 142 million). Given the strong liquidity, the company does not have any near-term financial risks.

NOA’s debt-to-equity ratio (or leverage) stands at 1.7x. In comparison, Helmerich & Payne’s (HP) and Superior Energy Services’ (SPN) leverage ratios are 0.11x and 3.0x, respectively. Despite such high leverage, S&P Global Ratings (“S&P”) changed the company outlook from “stable” to “positive” following the improved FY2019 guidance and longer-term outlook.

What Does The Relative Valuation Imply?

North American Construction Group is currently trading at an EV-to-adjusted EBITDA multiple of 7.9x. According to sell-side analysts’ estimates, the company’s forward EV/EBITDA multiple is 4.3x, which reflects analysts’ estimates of higher EBITDA in the next four quarters. From FY2013 to FY2018, the average EV/EBITDA multiple was 5.7x. So, the stock is currently trading at a premium to its past six-year average. The compression in the forward EV/EBITDA compared to the current EV/EBITDA multiple is steeper than the peers, which justifies the premium in its EV/EBITDA multiple compared to the peers. I have used estimates provided by Thomson Reuters in this analysis.

Analyst Rating

According to data provided by Seeking Alpha, five sell-side analysts rated NOA a “buy” in June (includes “outperform”), while none recommended a “hold” or a “sell”. The consensus target price is not available though.

According to Seeking Alpha’s Quant Rating, the stock receives a “Neutral” rating. Although its ratings are high on growth and momentum, they are moderate-to-poor on value, profitability, and EPS revisions. I agree with Seeking Alpha’s rating on growth because the company’s revenues and profitability growth were inconsistent in the past year. The high value on rating can be too optimistic, as I explained above in the previous section. The rating on EPS revisions may be too conservative because its earnings beat the analysts’ estimates in a couple of times in the past four quarters. The rating on profitability may also be too low because its profitability has not been significantly lower than its closest peers in the industry.

What’s The Take On NOA?

During Q4 2018, NOA added to its construction and mining assets through acquisitions. It has secured long term agreements with four major customers. Although the current slowdown in Canadian energy market activity can disrupt its growth prospect, positive signs are coming out of new construction projects. The production efforts at various mine sites are up, too. Although its leverage is higher compared to some of its peers, the company plans to deleverage its balance sheet significantly over the next three years. Investors may look to add this stock to their portfolio given the improving short-term drivers and the robust long-term drivers.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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2019-06-25