National Energy Services Is Potential Beneficiary of Further Middle East Tension

Middle East

Company history and business

National Energy Services Reunited Corp. (NASDAQ:NESR) provides oilfield services to exploration and production companies in the Middle East, North Africa and Asia Pacific regions. It provides an enormous range of services to upstream and midstream companies, but is geographically focused on the Middle East. The company debuted on the Nasdaq in May 2017. It subsequently acquired National Petroleum Services and Gulf Energy SAOC for $1.1 billion.

Financial strength

The company has $366 million in total debt. Broken down, it has a $525 million facility with a term loan of $300 million due in 2025, a $65 million revolver due in 2023 and $160 million in a working capital facility. Borrowings are at a three-month London Interbank Offered Rate plus 2.4% to 2.7% per annum. National Energy Services has drawn only $300 million of the term loan and $65 million of the revolving credit facility as of June 30.

The secured facilities agreement also includes covenants that restrict net debt-Ebitda to 3.50 and it includes a coverage ratio (cash flow / debt service) of at least 1.25 and interest coverage (Ebitda / interest) of at least 4 times. The company meets all covenants quite easily with $270 million in earnings before interest, taxes, depreciation and amortization and $37 million in free cash flow.

Management

National Energy Services’ chairman and CEO has been Sherif Foda since its inception. He has 25 years of experience, primarily at Schlumberger (SLB), where he served as president of Europe and Africa and as vice president of the Arabian market (which is where the company is focused now).

Chris Boone has been chief financial officer since May 29. Previously, he was CFO and senior vice president of Tesco Corp. (TESO), among other stints at the CFO level elsewhere. 

Valuation

The company is trading at 7.15 times free cash flow, 3.25 times enterprise value-Ebitda and with a price-earnings ratio of 7.77. This is quite cheap compared to competitors that trade between 6 and 13 times earnings. It is even cheaper because the company is expecting to grow. It does not seem unreasonable to expect some growth either, due to both its track record so far and recent geopolitical events.

Risks

There are a few important risks. Oil servicing companies are dependent on investments by exploration and production companies. If oil prices are low, there isn’t a lot of exploration going on while production slowly decreases. That’s a negative growth environment and services companies feel that. The new oil environment created through the U.S. shale boom has already taken us through a few curious oil price cycles in recent history. I don’t think we will retest the lows we’ve seen in past years, but it is always possible. In such an environment, it is extremely hard to do well.

Another risk is a massive conflict in the Middle East that takes out a lot of oil production, shuts down investment and, possibly, the company’s people and equipment ending up as collateral damage of terrorist attacks or in war.

Up to a full-blown conflict tension and small strikes in the region (like the recent, well-publicized drone attacks) could even be a positive. In fact, this is a reason I’ve taken a position in this company. It could potentially benefit to an inordinate degree from Middle East tension. It would benefit from the tailwinds of rising oil prices, but potentially benefit very directly by a lot of extra work being required due to damages caused.

Outlook

The company is focused on a region with the lowest break-even prices for oil in the world. This region is also intently focused on oil and is one of the last regions in the world I expect to try to strangle its energy industry with increased regulation. Proposals for increased regulation on U.S. shale, potentially increasing break-even costs by $10, get floated from time to time.

The company is projecting incredible revenue growth going forward (16% to 20%). I’m skeptical it is going to grow that fast. Maybe National Energy will post a number like that for one year, but it seems unsustainably high.

The industry can also be very lumpy, so it is not out of the ordinary to see revenue swings. The valuation suggests as much and actually implies we’re seeing cycle highs. That’s hard to believe for me given the geographical focus, the potential for increased business due to damages caused by guerrilla attacks against energy infrastructure and my expectation that oil prices have more upside than downside.

Disclosure: Author is long National Energy Services. 

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Bram de Haas

Bram de Haas is managing editor of The Special Situations Report and Founder of Starshot Capital B.V.

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