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Monday, April 9, 2012

GasFrac – Be Careful You do not Fall in Love with this Stock

I have often written about GasFrac Energy Services on this site (symbol GFS in Canada and GSFVF on the Pink Sheets). GasFrac is a “story stock”; in other words, the stock is valued based upon the story of what it could be rather than on the reality of what it is today. While GasFrac is getting close to accomplishing actual performance that will merit an increasing valuation, it is just not there yet. As a result, one of the main dangers with this stock (as with other story stocks) is falling in love with the story. An Investor has to maintain a rational and realistic view of the stock in order to make proper decisions regarding the company.

I am writing about this today, because there is an increasing amount of cheerleading hype being put out into the market as analysis of GasFrac’s prospects. Let me hasten to add first that I remain a bull regarding the long term prospects of GasFrac. The LPG completion method for oil and gas in shale formations is going to continue to win market share from conventional hydrofracking all across North America. The advantages of LPG both in generating better production and in avoiding all water usage and pollution have to win in the long run over hydrofracking. Nevertheless, articles are still appearing that portray GasFrac as the greatest investment in a long time, a dangerous and overly optimistic bit of advice. A good example of cheerleading arrived today: Nawar Alsaadi published a piece on Seeking Alpha entitled Gasfrac Energy, the Intel of Fracturing?

Mr. Alsaadi has written a string of informative pieces on Seeking Alpha about GasFrac. His articles have gotten more and more optimistic as time has passed, however. Now he is comparing GasFrac to chip giant Intel, and he does so because the Gasfrac annual shareholder report mentions a possible move into having other companies use the LPG technology. As I write this, Intel has a market cap of just under $140 billion. To say the least, it is way beyond GasFrac which has a market cap below half a billion dollars. But Mr. Alsaadi writes that licensing the LPG technology will produce huge gains for GasFrac. He accompanies the story with a chart that conveniently shows a “buyout window” and a NASDAQ listing for the stock in the future. Indeed, he basically shows that the sky is the limit for this future licensing revenue.

Let’s get back to reality. Right now, GasFrac is underperforming all of the old estimates that were done regarding its growth and future performance. The current consensus of six analysts for revenue in 2012 is $361 million and in 2013 of $499 million. As of last November, the same folks were estimating 2012 revenue of $446 billion. In June of 2011, the estimated revenue for 2012 was just under half a billion dollars. In other words, in just nine months, the consensus estimate for revenue for 2012 has gone down by just under 30%. The trend in estimated earnings has been the same. In just the last 90 days, the estimate for EPS for 2012 has declined from 88 cents to 45 cents. The estimate for 2013 has declined about 15% during that time as well.

The question, of course, that needs to be answered is what has caused this slowdown in the prospects for GasFrac. Here the principal answer is clear: there has been slower than expected growth in demand for the GasFrac process. A year ago, most of the investment community (myself included) bought into the story that the inherent superiority of the GasFrac process combined with the tiny market share that Gasfrac then had meant that demand for the process was essentially unlimited in the next few years. In other words, GasFrac could operate its equipment on the basis of “if GasFrac built it, they will come!” Unlike the baseball ghosts in the movie, however, the customers have not been breaking down the door at GasFrac to hire the company on to do fracking.

This is a key point when one thinks about what Mr. Alsaadi says in his article. Mr. Alsaadi is excited because licensing of technology will not require GasFrac to build as many sets of equipment; it can adapt the equipment of its licensees. Such a move, however, only expands capacity; it will not increase demand. GasFrac still has to win over the companies ordering well completion, a task which is harder than it seemed in the past.

The next six months are a critical time for the management of GasFrac to make clear that the company is on its way to winning over a substantial customer base. The long term contract with Husky and the smaller contract in the USA are a good first step, but they are far from sufficient proof of success. GasFrac will need to show a quarter or two of full capacity utilization (or at least something close) to show that success has been achieved on that front. In the interim the jury is out. To put it bluntly, the buyout window is closed for anyone viewing the situation rationally. The NASDAQ listing might be nice, but there is no reason for GasFrac to undertake all the costly obligations of American law that would come with such a listing.

Let me say it again, however. I remain a bull regarding GasFrac. I wholly expect that the company will leverage this great LPG technology into a thriving, prosperous company which grows into a larger part of the fracking industry. I also believe, however, that we should not let ourselves get carried away.

DISCLOSURE: I remain long Gasfrac stock. It is one of the larger holdings in my accounts.

7 comments:

Unknown said...

I appreciate you have taken notice of my article on Seeking Alpha, however I am not sure you have read the article; you mention that I compare it to Intel. I am only comparing it to Intel because this what I was told by the company as a "possible" model to compare to. Also, I am not saying it will get as BIG as Intel, I am saying the model is similar, there is quite a nuance here.

Also, you mention that the biggest question is not licensing, but demand, I think I made it clear in the article that there are challenges and I mention demand as one of the challenges, the other two are safety and technology adaptability to other platforms.

Finally, you mention analysts and investors were too excited about the company last year; please do note that my first article about the company was published in January of this year, I have only been bullish on them when they traded under $7, unlike many who were promoting them in the teens.

Regards,
Nawar

Jeff said...

Nawar:

Nice Try. You are not sure if I read your article? Really? You write an article whose title asks if GasFrac is the "Intel" of fracking and then tell us that you did not actually compare GasFrac to Intel? Again, really? You publish charts that have sections labelled "buyout window" but you are not in love with the stock? C'mon -- you know you love Gasfrac.

Look, there is nothing wrong with believing in a stock. You may well make a fortune doing so. I just think that if you are going to write articles (which, for the most part are very good), you should try to be a bit more objective.

I have to add that I, myself, was a bit in love with GasFrac in the past. I still think it likely that the company will do great things, but Zeke and friends are going to first have to prove it to me.

Unknown said...
This comment has been removed by the author.
Unknown said...

I am not sure that "love" has anything to do with it. Perhaps you are extrapolating from your own experience.

By all means you are entitled to your opinion about the company, its prospects, or its strategy, however I am not sure "guessing" about my emotional state is of any use to anybody.

Finally, I would like to say that I enjoy reading your blog and I find it objective and informative,

Nonetheless, it is clear disappointing to see the conversation stray away from the subject matter.

As a fellow Gasfrac shareholder, I wish you the best.

Regards,
Nawar

skpam said...
This comment has been removed by the author.
Scott said...

I think calling Gasfrac a story stock is a huge misrepresentation. A year ago you could have called it that. Since then Gasfrac has signed contracts for 3 or 4 of their sets of equipment and demonstrated effectiveness in a couple of plays in the USA (that we know about so far). And over the same period the stock price has declined.

Gasfrac trades at 1.6x book. That's a lot cheaper than other fracking stocks. 45 cents earnings for 2012 might not be as much as you hoped for this year, but it is only 15x earnings. Yeah I know that's a lot more than other fracking stocks which are (I think properly) being priced as if margins will decrease, but for a growth company it's really not a demanding multiple. 20 or 30x is quite common in the market for growth stocks.

Price does matter when it comes to deciding what is or isn't a story stock. 2013 estimates are 92 cents, and like with any other stock next year's earnings estimates are a guess. Story stocks don't trade at 7.5x next year's earnings and 1.6x book.

There is a story here, and Nawar has given the story in his article. The potential story is that this process will catch on in multiple basins in North America and overseas based on production alone and get additional business based on reduced environmental impact. This story is enhanced by the possibility that expansion could be achieved by licensing. So yes Gasfrac has a story, but is not a story stock because to achieve the current valuation you need nothing beyond the now reduced 2013 estimates to be achieved and no growth from that point on.

skpam said...

Jeff,

Thanks for the very thoughtful article on Gasfrac. I do like the company and the technology, but I remain cautious. I won't be surprised if the stock price is $20in a year, but I also won't be surprised if it is a $2 stock. I think the recent earnings report was a troubling "miss" on revenues.

SK