External banks on the long-term outlook
Exterran Corporation (EXTN) is in the midst of a business transformation. It is shifting its business portfolio to utility wastewater treatment and the desalination process for produced water in the United States and internationally. It is getting rid of non-essential and cycle-related products with lower margins to reduce cyclicality to improve operating margin. Thanks to recent ECO backlog projects, it can plug in product sales at an early stage and link them to AMS contracts for the operational part. He recently received multi-year project awards.
However, the unfavorable timing of global coin sales and declining product sales will continue to challenge its growth in 2022. Investors will have reason to worry about the heavy debt repayment charge in an effect balance sheet. leverage in the medium term. The stock is reasonably valued at this level. Despite the allure of robust profitability in 2022, I think the headwinds should cause investors to watch the stock cautiously.
With water now accounting for about 25% of EXTN’s $1.4 billion arrears, its management sees opportunities to integrate the natural gas business into water and mining. The second step in the company’s new strategy is to exit non-essential and cyclical products at lower margins. The company’s product pipeline now consists of a two-structured business that reduces cyclicality. However, it will continue to have natural gas operations with PEQ (North American generating equipment assets) and other North American compressor assets and Belleli. Investors may note that the company Belleli EPC (engineering, procurement and construction) manufactures tank farms for desalination plants in the Middle East.
Over the past few quarters, EXTN has transformed its international business as the markets for available natural gas and water have developed. The company has leveraged mining technology in the treatment of utility wastewater and produced a water desalination process. The expansion of municipal water segment technologies has gradually covered primary, secondary and tertiary water treatment. As crude oil production slowly increases, water volumes will increase due to the increase in the water-to-oil ratio. Read more about the company in my previous article.
Outlook: short and medium term
In fiscal 2022, management expects Adjusted EBITDA to increase by approximately 15% compared to fiscal 2021. The company also expects continued improvement in the business to result in improved working capital, asset sales and contract renewals, which would help to reduce debt in the years to come.
As part of the long-term diversification strategy, EXTN has expanded a $125 million ECO (Exterran Contract Operations) in Latin America. The multi-year contract will leverage its gas flotation technology. According to the company’s estimates, water accounts for around 25% of its ECO order book. To finance the project, the company can appeal partly to self-financing and partly to third-party funders. Thus, he can resort to the sale of products upstream and associate it with AMS contracts for the operational part. Management expects such structural change to bring significant growth opportunities in the future.
Natural gas price and production factors
The price of natural gas has increased significantly over the past year to December 2021. The EIA waits natural gas production is expected to remain virtually unchanged in 2022 from the current level. From December 21 to February 22, natural gas spot prices may average $4.58/MMBtu and decline to $3.98/MMBtu, on average, in 2022. It is difficult to estimate the cost due to demand volatility during the COVID relapse. A lower price would be unfavorable for natural gas processing and midstream infrastructure providers like EXTN.
Q3 Driver Analysis
In Q3 2021, revenue from Contractual Operations decreases compared to Q2 due to the acceleration of deferred revenue from the prior quarter. Revenue in the Aftermarket Services segment decreased by 16% compared to the previous year. The main reasons for the loss of revenue in the third quarter; unfavorable timing of global parts sales.
However, the Product Sales segment recorded considerable revenue growth (up 82%) in the third quarter compared to the previous quarter, while the adjusted gross margin almost tripled. Revenue in this segment benefited from higher projects in the Middle East, while margin improved (double digits) due to increased volume and lower under-absorption.
Order book refused
The Product Sales segment backlog fell 11% in the third quarter of 2021. A decline in backlog reduces revenue and margin visibility for the business in the fourth quarter and into 2022. EXTN had approximately 1.43 billion of unmet performance obligations as of September 30, 2021 in the contractual operations segment. The timing of milestone billings in the Middle East and Africa region reduced long-term contract assets in 9M 2021.
FCF and debt
EXTN’s cash flow from operations (or CFO) has improved significantly in the 9 months of 2021 compared to a year ago. This just addressed the fact that the company was generating negative free cash flow in recent quarters. Cash flow may continue to improve significantly in 2022 and beyond due to higher profitability. For fiscal 2021, its planned capital expenditure is $60 million (mid-term forecast), which is significantly higher than for fiscal 2020.
As of September 30, 2021, EXTN’s liquidity was $200 million (including working capital). With $576 million in debt due to be repaid between 2023 and 2025, barring further refinancing, the company’s financial risks are highlighted. Additionally, its leverage ratio (2.61x) is higher than many of its peers, which remains a concern for investors.
Forecast based on linear regression
Based on the historical relationship between key industry indicators and EXTN’s reported revenues over the past six years and previous eight quarters, I expect revenues to increase over the next twelve months. (or NTM). I expect revenue to stabilize in NTM 2023 and increase again in NTM 2024.
Based on a simple regression model using expected average revenues, I expect the company’s EBITDA to remain stable over the next two years. The EBITDA growth rate may accelerate in NTM 2024.
Target price and relative valuation
EXTN’s EV using past and future EV/Revenue multiple (1.02x) has a return potential of 445%, which is significantly higher than the return potential estimated by sell-side analysts (up 166%) of action. However, I think that the model and the analysts do not sufficiently take into account the risk factors and overestimate the returns.
EXTN’s future multiple contractions in EV to EBITDA versus 12-month adjusted EV/EBITDA are less pronounced than those of its peers. This generally reflects a lower EV/EBITDA multiple than peers. The stock’s EV/EBITDA multiple is below the average of its peers (GRC, BRC and TNC) of 21x. Thus, the stock is reasonably valued at this level.
What is EXTN’s point of view?
Exterran is slowly shifting away from non-essential and cyclical products with lower margins. The sustenance of the natural gas industry inside and outside the United States takes advantage of mining technology in the treatment of utility wastewater and the desalination process of produced water. It recently extended its $125 million multi-year contract operations in Latin America, which will leverage its gas flotation technology.
However, the price of natural gas should rise in the medium term, no doubt, but the COVID situation has clouded its near-term outlook. The cost may drop in 2022 as production increases. As revenue declined, the stock underperformed the VanEck Vectors Oil Services (OIH) ETF over the past year. Lower capital spending pushed free cash flow into positive territory. Given that the company has significant debt to repay over the medium term, I still doubt this bodes well for investor confidence. I think investors may want to hold and watch for now.