OGIB Bulletin #61 BI-WEEKLY WRAP – JUNE 10 2011

My full report on Xtreme Coil Drilling is complete and will be posted to the
website on Monday after I see what all the analysts are saying after the June 8
conference call – l. But I wanted to post something in the Bi-weekly wrap as the
stock dropped a lot around some soft Q1 financials – and guidance for continued
softness in Q2.
As background, Xtreme has everything I look for in an energy services company
– a proprietary technology, strong position in the market, highly valued stock it
can use as currency to grow. I like expensive stocks.
And after it dipped down a full $1/share for a financing ($5.75-$4.75) I thought
this was an excellent entry point and bought my first position after watching the
stock for weeks and interviewing management.
They have three high growth areas
1. the international arena (Saudi Arabia and Australia)
2. service rigs – with 50%-100% higher margins than regular drilling
3. a new mining drilling initiative that would be low cost and high margin
But then on June 7 the company announced soft Q1 2011 financials when it was
being valued as a high growth stock. And on June 8 in the conference call they
warned that Q2 EBITDA would also be lower than the street was expecting.
I confess I did not see that coming.
The stock was soft on June 7 and closed below the recent issue price of $4.75,
and after that conference call on June 8 it closed down another 5%, though on
very small volume.
The reasons were some unexpected downtime on a couple rigs in the US, and a
small bit of downtime in Saudi Arabia with partner Baker Hughes.
While the company has a lot going for it
– $50 million new equity (total cash now $15 million) and $90 million new debt,
– a fairly new fleet of drills, going from 16-27 including 8 high margin service rigs
I suspect the company’s valuation may now suffer for at least the next couple
quarters. And what I mean by that is that I see the valuation of Xtreme now
being closer to its peer group of 7.5 – 8x EBITDA, vs the 11x plus it had before.
Because it’s clear to me that given the timing of its new service rigs being put into
service, that 2011 EBITDA for Xtreme will now be much closer to the $22 million
of 2010 than analysts 2011 predictions of $31 million. There was $4.1 million in
Q1, and management indicated perhaps $4.6 million in Q2 – a total of $8.7
million. With most of the service rigs being put into service in Q4, it’s unlikely Q3
EBITDA will be over $7 million. Q4 definitely has potential to be a GREAT
quarter, but the new service rig pricing will be to get customers interest. Pricing
could move up quickly in 2012 once their proof of concept – “Big 22,000 foot
horizontal cleanouts are Xtremely easy and quick” – is complete.
Ok, that last line was a bit facetious. But I need some humour. I hate being
underwater on any trade, and I expect to be 10%-15% underwater until at least
the next quarterly comes out.
There is A LOT of growth potential here; a lot of moving parts, and the stock is
well supported by The Street, it’s tightly held (50% by management and a couple
institutions)….but now I think there’s a good likelihood the stock will trade below
the recent financing price until management proves they can build and sell these
service rigs on time.
Several analysts were asking about the timing of delivery on these five rigs that
Xtreme bought in February and are converting to service rigs. Any delay on that
early Q4 delivery time (and management did say it could be Q1 2012 for the last
couple) I expect the stock to get punished.
It’s tough on both management and the underwriters (and newsletter writers),
explaining to retail clients how you could like a company so much and raise $50
million and then see a couple soft quarters get announced within 10 business
At the end of the day it doesn’t matter – it is what it is. I now believe there is a
strong possibility the stock will trade in the low-mid $4 range for a couple
quarters, especially on light summer volume. This has now become a “Show
Me” stock. At least for me it is.
One analyst has lowered their target on the stock by $1 from $7.50 to $6.50, and
reduced 2011 EBITDA expectations by $2 million from $31 – $29 million. The
analyst still believes in 2012 EBITDA of almost $60 million – as do I. Another
analyst dropped 2011 earnings to 18 cents from 29 cents, but again kept 2012
estimates intact. And that was the theme across the five Canadian analysts that
follow the story (Peters, Altacorp, Macquarie, Canaccord, Cormark). My EBITDA
guesstimate for 2011 is the lowest of anybody, but not by much.
Potential summer catalysts for the stock include
1. the mining joint venture going ahead (and hopefully an idea on the
economics of this business),
2. their two small rigs that are idle being contracted,
3. the arrival of key components for the service rig conversions that would
satisfy the market they will be delivered in early October as expected
The good news is that 13 of the current 16 rigs are under long term contract,
there is a viable three pronged growth strategy but it may take a quarter or two
longer than The Street expected to get traction on that growth. This is only a 1-2
quarter setback and I am not a seller.
Golar announced its Q1 2011 numbers, and made some of the best information
both public, and easy to understand – a welcome change!
I’ll go through the numbers first and explain their new structure and strategy
Overall revenues were $67.5 million, up from $64.6 million Q4 2010, despite
lower ship utilization. That’s because day rates went from $74,206 to $80,694
during the quarter, and they said rates are now over $90,000 a day for LNG
tankers. Net income was $16.3 million, more than three times Q4 2010 net
income of $4.1 million.
Golar Commodities – their trading arm – continues to lose money – $3.6 million in
Q1. They trade physical cargos and financial derivatives – the first makes
money, the second one loses money. They did give guidance that some physical
cargo trades will show a profit in Q2.
They announced a continued 25 cents a share dividend for this quarter – and
that is actually an overall increase in cash as there is now 79.8 million shares
outstanding after the complete takeover of Golar Energy, which was listed on the
Oslo Stock Exchange only.
That means I now have clarity on share structure and dividend. Plus, their
holding in the new GMLP-NASD listed Golar LNG Partners was worth $714
million and Golar expects to bring up $10 million per quarter from GMLP into
Golar (GLNG) in GMLP dividends. GLNG owns 67% of GMLP – the public owns
the rest, which it bought on the IPO in Q2 at $22.50.
Now that Golar (GLNG) has absorbed Golar Energy, they have decided to
change strategy a bit. Golar Energy was going to do short term, spot business in
the LNG market. But then the tight tanker market – while good for GLNG’s day
rates – made life hell for Golar Energy. There was no product! All the ships were
spoken for.
So now Golar (GLNG) will do the short term business, and the newly listed Golar
(GMLP) will do both the long term LNG tanker contracts AND ALL THE FSRU
business – Floating Storage and Regasification Units. These are the ships that
turn Liquid Natural Gas (LNG) back into regular dry natural gas (methane) that
you and I can heat our homes with.
So while Golar (GLNG) used to be the long term pubco, it’s now the short term
one. But Chairman John Frederiksen still owns 46% of Golar (GLNG) and GLNG
owns 67% of GMLP, so he still controls everything through GLNG, so that’s
where I will keep my money.
In giving guidance, management said they expect to hear back on at least three
and possibly five FSRU contracts by the end of 2011, on which they have
submitted bids. (Golar has never lost an FSRU contract that got completed.)
They also intimated they were lucky to get Samsung, the Korean conglomerate,
to build them 6 new LNG tankers for 2013 and 2014 as shipbuilding capacity is
also very tight globally. 35 new LNG tankers are on order worldwide now, 16 of
which were just ordered since January. They should be coming onstream just as
the huge Australian LNG plants open. Australia will probably be a bigger LNG
exporter than even Qatar then. But for the next 2-3 years, LNG tankers will
enjoy a very tight market, and strong pricing power.
In closing, here are the two paragraphs that intrigued me most from their
quarterly. Subscribers should remember this is a very exciting time for this
industry as it is making LNG a true global market for the first time ever in 2011.
It’s kind of like horizontal drilling and fracking – they have all been around for
awhile now, but are just hitting their stride and being adopted by the masses,
creating BIG opportunities for investors – and I have already benefited this as
Golar LNG has doubled for me.
“The next wave of midstream LNG solutions continues to be developed inside
Golar. Floating LNG to power vessel, floating storage and small scale LNG are
all on Golar’s drawing board and the Company anticipates they could all add
significantly to our growth in the future. It is the Company’s target to conclude
firm business for at least one of these projects before the end of the year.

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