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.