ProPetro Holding Corp (PUMP)

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Key Statistics

Enterprise Value = $1.024 billion

Operating Income = $233.82 million

EV/Operating Income = 4.38x

Earnings Yield = 13%

Price/Revenue = .63x

Debt/Equity = 17%

The Company

ProPetro is a Midland, Texas-based oilfield services company. The company’s focus is providing equipment and services to support the fracking industry with a concentration in the Permian Basin.

The Permian Basin is an ocean of oil, currently producing 2 million barrels of oil a day. PUMP owns and operates a fleet of mobile hydraulic fracturing units. Other companies pay ProPetro for the use of these units, along with the supporting crew which operates the equipment. They provide equipment, personnel, and services to meet the needs of their clients that work in the Permian Basin. They have strong relationships with their clients and are local to the Permian basin, giving them a substantial advantage in this region due to the relationships that they have in place.

This is a company whose fortunes are directly tied to the performance of fracking in the United States, which is directly linked to oil prices.

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Oil has been hammered recently, which led to a decline in the stock price.

PUMP has been punished further in the recent market sell-off, pushing it below its 2017 IPO price of $14.50. This is a small company in a rocky industry and has been, in my opinion, oversold because it is perceived as a risky small cap in a risky industry.

My Take

I am optimistic about the fracking industry, primarily due to the fact that it defied all expectations and survived the misery of the 2015-16 oil price crash. This was a crash that was engineered by Saudis who increased oil production to cripple the fracking industry in the United States. Fracking is only profitable at high oil prices, and the Saudis hoped to cripple the industry by boosting production and lowering the price. They did not succeed despite their best efforts and fracking, while damaged over the crash, survived the crash.

With that said, there is a lot to dislike about the industry. The oil crash of 2015-16 led to a string of bankruptcies among the highly indebted companies in the space. There is also criticism that the industry is too capital intensive and can’t produce sufficient free cash flow to be viable for the long run. The only thing supporting the industry, critics say, is a flood of cheap money from yield-hungry investors and greedy Wall Street banks determined to earn fees while they hold their nose over the stench of crappy deals. Adding more support to the “ick” factor is the environmental criticism of the industry.

Add up all of this and what do you get? An industry ripe for mispricing because of the revulsion is creates. I think ProPetro has been punished unnecessarily by this sentiment.

The speculative nature of this trade is that I am betting that oil prices are close to a cyclical low. The Saudis seem strongly incentivized to increase the price of oil, and they are already taking action to make this happen. They want to take Aramco public in the near future. To get the best possible offering price, they need to maximize the price of oil. This is going to benefit fracking, to the long-term detriment of Saudi Arabia but it will support their short-term interest to maximize the price of oil so they can get the most money out of their IPO.

ProPetro is uniquely positioned as one of the key players in the Permian Basin, which is a hub of fracking activity in the United States. They will benefit immensely by an increase in oil prices.

Even if I am wrong and oil heads lower, ProPetro held up nicely during the 2015-16 crash. They were able to eke out positive operating income in 2015 of $8.78 million and lost only $37.38 million in operating income in 2016. Once oil prices bounced back slightly in 2017, ProPetro came back to life and generated an operating income of $63 million. This suggests to me that even if my thesis is wrong, ProPetro should survive a downturn in the fracking industry and minimize my losses. Furthermore, I purchased the stock at such a significant discount to intrinsic value (4.38x Operating Income, a 13% earnings yield, and only 5 times cash flow), that the stock price should hold up in a downturn.

If my thesis is correct and the Saudis engineer a hike in oil prices to support their IPO, fracking in the United States ought to boom and ProPetro’s multiple ought to improve significantly.

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.