Even after Biden’s words, nine energy is undervalued (NINE)

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Nine Energy Service, Inc. (NYSE: NEW) saw its shares rise in the open market after the company released a recent quarterly report. The company seems to be benefiting from the increase in the price of oil and gas and equity market analysts have recently noted very favorable expectations for NINE’s business model. According to my own discounted free cash flow models, I got a valuation of almost $13.69 per share, which is higher than the current share price. The total amount of debt seems significant. However, with sufficient free cash flow generation, I think debt doesn’t seem to be an issue.

Nine Energy has links with many players in the oil and gas industry

Nine Energy Service, Inc. is a service provider to the unconventional oil and gas industry in North America and overseas. Nine’s specialization includes multi-stage horizontal wells for production, cementing, cable and coiled tubing services among many other applications.

Recall that the board of directors includes staff who sit on the board of directors of large companies. This means that Nine Energy administrators will be able to enter into contracts with relevant industry players.

Mr. Baldwin has been a director of the Company since February 28, 2017 and served on the board of directors of Beckman Production Services, Inc. prior to its merger with and into the Company on that date. He currently serves on the board of directors of Select Energy Services, Inc. (WTTR) and Oil Patch Group, Inc. Source: Board of Directors – Corporate Governance | New Energy Service

Mark Baldwin has been a director of the Company since May 10, 2013. Mr. Baldwin has been a director of KBR, Inc. (KBR) since October 3, 2014 and a director of TETRA Technologies, Inc. (TTI) since January 16, 2014. Source : Board of Directors – Corporate Governance | New Energy Service

Analysts predict sales growth of 69% in 2022 and 20% in 2023

I think analysts’ expectations are quite beneficial. For 2024, analysts have forecast that with net sales of $820 million and growth of 15.01%, EBITDA would be $173 million with an EBITDA margin of 21.10%.

Source: Marketscreener.com

Source: Marketscreener.com

2024 operating profit would be close to $132 million with an operating margin of 16% and pre-tax profit of $99.1 million. In the end, the net result would be close to 98 million dollars with a free cash flow of 97.9 million dollars and an FCF margin of 11.94%.

Balance sheet

As of September 30, 2022, with cash and cash equivalents of $21.490 million in addition to accounts receivable of $103.881 million, Nine Energy’s inventory was $52.959 million. In addition, total current assets amounted to nearly $189 million. Considering the amount of current liabilities is close to $102 million, I think Nine Energy is unlikely to face a liquidity crunch anytime soon.

Non-current assets include property, plant and equipment of $75.6 million, right-of-use operating lease assets of $35.934 million, and intangible assets of $105.840 million. Finally, the total assets are worth $407 million. Note that the asset/liability ratio is less than one, which most investors may not appreciate.

Source: 10-Q

Source: 10-Q

Liabilities include accounts payable of $38.145 million, accrued liabilities of $29.374 million and a current portion of long-term debt of $27.281 million. With a current portion of operating lease obligations of $7.438 million, total current liabilities were $102.658 million.

Long-term debt is $305 million with long-term operating lease obligations of $29.612 and total liabilities of $439.560 million. Keeping in mind that the company’s 2024 EBITDA is expected to be close to $173 million, the debt close to $333 million doesn’t seem that big.

Source: 10-Q

Source: 10-Q

My conservative case scenario involves a fair price of $13.69 per share

With customers in Norway, I believe most customers are located in the United States. With this in mind, in my view, internationalization can bring significant revenue growth in the years to come.

Source: company website

Source: company website

According to the latest quarterly report, Nine Energy generally signs Master Service Agreements with its customers. With this in mind, I believe the level of personalization and service to each client requires a great deal of attention. This means that Nine Energy will likely develop great relationships with many industry clients.

We typically enter into a Master Service Agreement with each client that provides a framework of terms and conditions for our services that will govern any future transactions or work assigned to us. Each specific job is obtained by tender or following negotiations with customers. The rate we charge is determined by location, complexity of work, operating conditions, length of contract and market conditions. Source: 10-Q

Under normal circumstances, I think the buyback program that Nine Energy is running will likely bring demand for the stock. Keep in mind that the company only acquired 0.122 million shares in September 2022. More shares repurchased will likely lower the cost of equity, which could improve Nine’s fair price.

Source: 10-Q

Source: 10-Q

Under the above conditions, I designed the following scale model. 2030 net sales are expected to be close to $914 million with sales growth of 8%, in addition to an EBITDA of $128 million and an EBITDA margin of 14%.

I forecast an FCF of $82 million with an FCF/sales of 9%. If we also include an EV/EBITDA of 12x, the exit term would be $1.53 billion. The sum of discounted free cash flow with a WACC of 14% involved $766.43 million. If we also include debt of $333 million and cash of $21 million, equity would be $454.92 million. Finally, the internal rate of return would be 5.73% with a fair price of $13.69 per share.

Source: Bersit DCF model

Source: Bersit DCF model

In very bearish conditions, I believe the fair price can reach $8.095 per share

Nine Energy could suffer significantly from a drop in the price of oil and gas or a decline in industry investment forecasts. As a result, management could sign fewer Master Service Agreements, which will likely reduce the company’s sales growth and free cash flow margins.

Even with favorable oil and natural gas prices, E&P operator activity may not increase significantly as they remain focused on operations as part of their capital plans. In addition, any unexpected significant decline in commodity prices in the future could have a material adverse effect on our business, financial condition, results of operations, cash flows and prospects. Source: 10-k

I also expect demand for the stock to decline if Nine Energy continues to receive written notices from the NYSE regarding compliance standards. Keep in mind that not trading on the NYSE will reduce the visibility of the stock and may increase the cost of equity. In short, the fair price would probably decrease.

Our common stock is currently listed on the NYSE. On January 5, 2022, we received written notification from the NYSE that we no longer met the standards for continuous listing compliance set forth in Section 802.01B of the NYSE Listed Company Manual. Source: 10-Q

I also think the new rules announced by Biden to regulate the oil and gas industry and methane emissions would affect the company:

The Environmental Protection Agency said the proposed standards would reduce methane from the oil and gas sector by 87% from 2005 levels. Source: Biden targets methane emissions with new rules on the oil and gas industry.

Under very bearish conditions, I believe Nine Energy may struggle to repay all of its outstanding debt. In the last annual report, the company noted that future free cash flow may not be sufficient to pay the company’s total financial obligations.

Our ability to make our scheduled debt payments depends on our financial condition and operating performance, which are subject to prevailing economic and competitive conditions and certain financial, business and other factors beyond our control. If our cash flow and capital resources are insufficient to fund debt service obligations, we may be forced to sell assets, seek additional capital or restructure or refinance debt. Source: 10-k

In this scenario, I used 2030 net sales of $755 million with sales growth of -2.50%, EBITDA of $106 million, and EBITDA margin of 14.5%. Furthermore, I expect an FCF close to $68.5 million with 9.5% FCF/sales.

If we use an EV/EBITDA of 10x, the 2030 exit value would be $1.057 billion. The results using a 15% discount include an enterprise value of $580.40 million and an equity valuation of $268.89 million. Finally, with a number of shares of 33.221 million, the internal rate of return would be -1.73% and the fair price would be $8.09 per share.

Source: Bersit DCF model

Source: Bersit DCF model

Conclusion

Nine Energy benefited from the recent rise in oil and gas prices. Most analysts are expecting very decent sales growth and a double-digit EBITDA margin for the next two years. Given the share buyback enacted by Nine Energy, I think the stock price will likely head north soon. In my own discounted cash flow models, the fair price appears higher than the market price. Even given Biden’s talk about new oil and gas industry rules, the company’s total debt load, and other risks, Nine Energy looks pretty undervalued.

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