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Pulse Data (PSD.TO): Another Low-Risk Oil and Natural Gas Service Stock

July 15th, 2008 by Yehuda Fruchter | 1 Comment

Introduction:
We first wrote about Pulse Data (PSD.TO) nearly two years ago, on our previous blog, CasinoCapitalism.com. Since that time, the shares have basically moved nowhere. However, we think that due to certain company changes and industry events, PSD.TO may finally provide patient shareholders a significant return in the coming year. At the same time, downside risk seems low given the company’s continued buyback program, a price that is below a previous takeout over, and considering the company’s stable and high dividend yield (6.8%).

What Does PSD.TO Do?
Pulse Data is a licensor of 2D and 3D seismic data in Canada. In fact, Pulse owns the second largest seismic data library in Canada.

What Went Wrong at Pulse?

Non-Core Business Produced Losses

Up until recently, Pulse Data owned another non-seismic related business called Terrapoint, which supplied LiDAR services. This business routinely lost money, distracted management, and may have dissuaded investors looking for a pure play seismic company from investing in PSD.TO.

Slowdown in Canadian Drilling Cap-Ex

As Pulse explains:

“In 2007 the new Alberta royalty program and the related uncertainty led many Pulse clients to re-evaluate their spending strategies, while in 2006 the federal government’s announcement of the future taxation of income trusts beginning in 2011 caused a similar environment of concern.”

Confusing Financials and Low Accounting Earnings Because of Less Participation Surveys

In general, most investors, particularly the momentum players, understand one thing when it comes to stocks: Accounting Earnings and EPS. However, for some companies accounting earnings show a very misleading picture. This situation is very acute for seismic licensors since their two means generating revenue (i.e. data licensing and seismic surveys) have two very different impacts on accounting earnings and cash-flow. In addition, the high level of amortization at seismic companies is overlooked by investors who are focused more on accounting earnings. Basically, while data licensing greatly increases cash-flows it has no real impact on accounting earnings. At the same time, seismic surveys positively impact earnings and yet are cash-flow negative.

This is how Pulse describes it:

“Participation surveys create a misleading picture of revenue and earnings. Participation surveys are new, generally 3D seismic surveys which Pulse leads and to which one or more customers contribute to the initial cost. These contributions generate high levels of recorded revenues.

But because the entire capital cost of the participation survey is capitalized and amortized, only a portion of the cost is recorded against the revenue. This accounting results in “earnings” – taxable earnings. Yet 100 percent of the funds are tied up in the survey. Participation surveys essentially create a “false positive” reading for investors. In fact, they usually generate negative free cash flow in the year they’re conducted. ”

So to the extent that Pulse has decreased participation surveys which it did, accounting earnings will suffer and many investors will ignore the stock.

What Has Changed?

Non-Core Terrapoint Business Was Sold

Recently, Pulse announced the sale of its Terrapoint business. As Pulse explains:

“Pulse now focuses on what it does best: growing its 2D and 3D library of seismic data that is located in active exploration areas in western Canada, and marketing that data to the oil and natural gas industry. We have divested of non-core subsidiaries. Result: a pure play in a business niche with growth potential.”

Higher Natural Gas Prices and Regulatory Changes: Improve Outlook for Data Licensing and Participation Surveys

Pulse states:

“after a two-year period of weakness, the recovery in natural gas prices began in the first quarter of 2008 and accelerated in the second quarter, with the Nymex natural gas futures price approaching $11 per mmbtu in late April, 2008. In early April the Government of Alberta announced revisions to its new royalty program that should partially restore deep oil and natural gas drilling incentives. This announcement removed an important element of uncertainty and potentially improves the economics of deep wells drilled in 2009 and beyond. Finally, strong successes experienced in exploratory drilling of several large unconventional natural gas and crude oil plays (including areas in which Pulse provides seismic coverage) are generating industry excitement and motivating new activities by competing companies. All of these factors bode well for seismic library data demand as well as increased demand for new participation surveys.”

Given the above, we expect very strong revenue generation and cash-flow from Pulse in the year ahead.

More Participation Surveys Increase Earnings and Could Generate Investor Excitement

As Pulse explains,

“In 2007 and 2006 Pulse concentrated on acquiring data by purchasing pre-owned datasets rather than committing its capital to participation surveys, partially because field acquisition costs were significantly elevated during this time. In 2008, given a more favourable industry cost structure, the Corporation plans to resume a higher level of participation surveys. The effects of seasonality on the timing of participation surveys are changing slightly, and the Corporation expects to conduct participation surveys throughout the year as opportunities arise.”

Even though accounting earnings are not relevant to the value of the company in reality, most investors (and many quantatively-based investment strategies) only focus on accounting earnings gains. As such, the growth of participation surveys, should greatly increase PSD.TO’s earnings in the year ahead and hence bring in more investors into the stock.

Risks
The basic risk for PSD.TO as for any oil/natural gas service related play is greatly reduced commodity prices.

Valuation Downside/Upside
In order to best understand the following discussion, please view our spreadsheet for PSD.TO at:

http://spreadsheets.google.com/pub?key=pb-Z9URIzMG28Zo1kIdKkcw

In attempting to prove that Pulse Data has low downside risk at this level, I think there are four main considerations:
1. Stock is still trading about 10% beneath Seitel’s last offer of around $3.20 per share. We think that an offer price from a credible competitor is probably the best measure to use for the base value of PSD.TO’s shares.
2. Additionally, on several valuations measures, the stock is trading at a very low valuation. Management claims that PSD.TO’s seismic data has a $1 billion replacement value. However, even ignoring that number, which seems somewhat exaggerated, the stock is trading at EV/TTM EBITDA of 5, notwithstanding 80% EBITDA margins. This is cheap. Even on a fully-taxed EV/FCF of less than 15X.
3. PSD.TO management continues to buyback shares at prices near the current price. Recently, the company bought 1.2 million shares at $2.75.
4. The company’s dividend of $0.20 per share per year implies a yield of 6.8%. This is extraordinarily high considering current money market rates. Notably the dividend is safe and could quite possibly grow in the next year.

In attempting to forecast an upside price, we’ll go with $5 (a 70% gain). This would represent 8.5X TTM EBITDA.

Conclusion

Given the strong odds of improving results at PSD.TO over the coming year, and the low valuation of the shares, we think PSD.TO offers an excellent investment opportunity.

Disclosure: I am currently long shares of PSD.TO and I may buy and sell shares at any time without telling you about these actions. I do not have any obligation to share with you any updated information about PSD.TO in the future.

All ideas, opinions, and/or forecasts, expressed or implied herein, are for informational purposes only and should not be construed as a recommendation to invest, trade, and/or speculate in the markets. Any investments, trades, and/or speculations made in light of the ideas, opinions, and/or forecasts, expressed or implied herein, are committed at your own risk, financial or otherwise.

Outlook for Oil Service Shares

January 9th, 2007 by Yehuda Fruchter | 1 Comment

As oil prices continue to be weak, and shares in oil service providers remain in the doldrums (i.e. check out the OIH performance over the last six months and year), we thought we’d share some interesting historical figures for those still bullish on the sector.

According to Simmons and Company, the leading independent investment bank in the energy industry (Note: Emphasis added by Envoy Global Research):

“During the 1970s, the oil service stocks realized stellar performance. For example, from 1970 through 1979, the stock price of SLB increased ten-fold. The ascent was dramatic in absolute terms as well as relative terms as SLB eclipsed the broad market (measured by the S&P 500) which rose a meager 16% over this period. Even so, the ascent was not a smooth climb. Oil service stocks enjoyed their most significant gains in the early 1970s and late 1970s due in large part to the Arab oil embargo of 1973 and the Iranian oil embargo of 1979. Our focus is on the less volatile stock price period from 1975 through 1978, a time when oil services experienced robust gains, but also hit a plateau for a 20-month stint during 1976 – 1978... The absolute returns on the oil service stocks were spectacular. The composite posted gains of nearly 300% between 1970 – 1973, 80% between 1975 – 1978 and 200% between 1979 – 1980…As shown below, the P/Es contracted meaningfully during the steady growth, lower volatility period from 1975 – 1978. Although a significant component of the contraction was driven by the broad market P/E retrenchment, the trend is clearly evident on a relative P/E basis as well. While one might argue that P/Es typically contract as up-cycles unfold and that the reduction in relative P/Es during this time was reflective of the maturation of the cycle, two pieces of data counter this position. First, relative P/Es were expanding during the explosive growth period of 1970 – 1973 and relative P/Es expanded rapidly in 1979 – 1980 as explosive growth and greater volatility returned.”

Source: Simmons and Company, Intl. 12/03, The More Things Change the More They Stay The Same

So what do we take away from all of this?

Well firstly, we’d caution like Simmons, that parallels between today’s environment and the 70′s are hardly perfect and it would be silly to simply extract findings from the 1970s and haphazardly apply them to today’s energy markets without an extensive comparative analysis. Nevertheless, on a simple level, and simplicity perhaps is the key to investment success, the above numbers suggest to us that if you missed the first big run in oil stocks earlier in the decade, not to worry, they’ll be another big run before the end of the decade. The culprit, sadly, will probably be some major geopolitical event. In the meantime, start gathering a list of the most attractive names in the energy sector for purchase during this period of price consolidation. We would expect that entry back into the sector will prove profitable late this year or in early 2008 after performance-chasing funds grow tired of the once hot sector.

Stock to Watch: Seitel (SELA.ob)

October 13th, 2006 by Yehuda Fruchter | 1 Comment

Note: Since this is a watch list stock, we have only provided an investment summary.

If you’ve been following our stock picks, you know that we occasionally recommend investments in M&A risk-arbritage situations. Specifically, we recommend taking stakes in companies that have an existing acqusition offer on the table and the stock is trading well beneath the existing acquisition price. PCNTF and STLW, two stocks that we recommended and continue to hold, were examples of this type of situation.

Additionally, if you’ve been reading our blog from some time, you also may know that we made subscribers a significant amount of money in the last year by recommending investments in seismic data companies. These companies offered the perfect combination of post-bankruptcy restructuring situations, favorable industry dynamics, M&A activity, and low Wall Street research coverage. Seitel (SELA.ob) was our top pick in the seismic sector and it rewareded us nicely.

We continue to hold Seitel (SELA.ob) and we want to remind investors that in August 2006, ValueAct Capital offered to buy the company for $3.65 per share. In the interim oil prices have plummeted and Seitel’s stock price has dropped beneath ValueAct’s offer. Without getting into detail here, we think that should the stock trade at a more than 10% discount to the offer price, or about $3.25 per share, the stock will start to offer an interesting trading opportunity. Can this happen? We’re sure that it can given the continued pessimism towards oil-related shares.

The Perfect Marketing Timing Tool

June 8th, 2006 by Yehuda Fruchter | 1 Comment

The holy grail of traders is a foolproof market timing tool. It helps you buy at the bottom and sell at the top. Now of course this is impossible to do in practice, but that does not mean I’m going to give up my hunt for that elusive market timing indicator. The potential profits are just too alluring.

T-3 Energy Services (TTES) Earnings Update

March 8th, 2006 by Yehuda Fruchter | No Comments

T-3 Energy Services (TTES) just reported excellent fourth quarter earnings. It´s hard to know how to value this company, given its exposure to the cyclical Oil and Gas industry, but the numbers sure make us optimistic about the coming year. Given the extremely low float in this stock, a modest valuation upgrade for the shares (they currently trade at less than 12X forward estimates, even though the company is growing at triple digit rates) could send the stock up 45%. At the same time, the downside appears quite limited because of the much improved balance sheet, solid business outlook, strong earnings growth expected during 2006, and the current low valuation.

T-3 Energy Services (TTES)

October 14th, 2005 by Yehuda Fruchter | No Comments

I just bought some more of TTES at $12.13. The stock, like many other energy plays, has dropped significantly in the last few weeks, pretty much back to where I first bought it in August.

Before getting to this particular pick, I do believe that energy stocks, in general, are good buys here. The stocks have recently sold off dramatically, for no apparent reason,
other than that crude oil is down a bit, and speculators in the energy
stocks are either booking gains and/or taking losses. As always, though, I’m generally inclined to purchase stocks like TTES over other stocks in these types of declines, since there is a special situation here which, to my mind, limits the downside risk.

In any case, the long-term outlook for energy is still very bullish. I doubt, as the market appears to imply, that the world’s supply/demand issues energy has changed dramatically in the last three weeks. Once again, it is the casino atmosphere of the market, with little attention paid to actual business fundamentals, which is causing prices to fluctuate wildly. I’m not sure many people realize that oil at $40 is still very bullish (all the stocks are valued at $40 or so a barrel and big companies have already hedged to benefit for quite some time from high oil prices). For a good discussion of oil investing see this post: http://lobg2.blogspot.com/2005/10/items-of-interest.html (read the section entitled: “Still Stoked About Energy”).
Now on to why you should buy TTES.