An investment in Heckmann Corporation (
) ("Heckmann", or "the company") is premised upon an experienced
management team's ability to execute upon an enormous opportunity
to provide fluid and waste handling services to drillers of
unconventional shale gas resources. In the 1990's, this management
team turned a very small water filtration company (US Filter) into
a colossal success and is confident of doing the same again.
HEK is a relatively new company that is operating in a young
industry and the business is expanding quickly, so it is very hard
to determine how much the business may be worth a few years from
now. However, we have a good sense of the current and potential
profitability of the company over the next 12-24 months and
therefore can determine what multiple of those profits we are
willing to pay for.
Over the past few years, the nation's largest unconventional
drillers have primarily used small "Mom & Pop" companies to
handle their fluids handling. This, of course, is where the
opportunity lies for a roll-up of the industry as these drilling
companies would much prefer to have a $1bn company, that has the
capacity to indemnify them against potential spillage and provide
them with a one-stop solution for all fluid disposal needs. As a
result, we believe that Chairman Dick Heckmann will continue to
roll-up this fragmented industry in a similar fashion to how he did
with US Filter (which Mr. Heckmann acquired when it had revenues of
$7mm in 1990 and sold it to Vivendi for $8bn in cash in 1999, after
acquiring 260 companies in the process). But we are not paying for
that growth prospect at present share price levels. Heckmann counts
Shell (RDS.A), Exxon Mobil (
), Hess (
), Chesapeake (
), Encana (
), Chevron (CVX), Anadarko (APC) and Halliburton (HAL), among
others, as its customers.
Most importantly, we believe that the unconventional shale
industry is still in the 1st inning of its duration as an industry.
While recent low domestic gas prices have indeed caused a material
slowdown in unconventional well fracking (notably in H2/12), we
believe that activity has stabilized in many shale plays.
Importantly, from a revenue standpoint 70% of HEK's shale business
is related to liquids and oil drilling and the current level of
$95/bbl WTI makes these wells hugely economical (Continental
Resources (CLR) recently reported that the company could still earn
20% compounded IRRs in its Bakken wells at $60/bbl oil). As a
result, the company is less exposed to dry gas drilling than it was
12 months ago (however, the Haynesville pipeline is still in place
and can become meaningfully profitable should gas prices
We note that HEK's recent purchase of Power Fuels has garnered
some bearish attention in an oft-repeated bear thesis that rental
revenues (associated with Bakken frac tank rentals) may have
deteriorated sharply in the back half of 2012. We do not dispute
this, but we believe that the news is old, and is factored into the
company's current share price of $3.80. We also are of the opinion
that this deterioration troughed in Q4 and has stabilized since.
Indeed, HEK's management pro-actively warned that this would occur
with the release of the proxy statement associated with the
acquisition of Power Fuels.
It should be noted that the combined shareholdings of Chairman
Dick Heckmann and CEO Mark Johnsrud aggregate to 50% of the shares
outstanding, so the management's incentives are meaningfully
aligned with other shareholders. In addition, the significant short
interest of over 30% (as a % of the company's free float) infers
that there could be significant buying appetite as the management
begins to deliver improving results, which we believe should occur
from Q2/13 onwards (as drilling activity potentially increases from
We estimate that organic EBITDA growth will average
approximately 10%+ between 2012 and 2014,
using conservative growth and margin assumptions.
The current price implies a P/E of 10x and an FCF yield of 7%
predicated upon our estimates for 2014e EPS and FCF per share,
respectively. But relying on this would not be doing the management
team justice as they have proved themselves to be masters of making
accretive acquisitions and therefore we believe that reported
EBITDA growth can grow much faster than our Base Case estimate. In
addition, should domestic gas prices revert to the area of
$4.00/mcf and oil prices remain at current levels, HEK's organic
growth could be far in excess of what we have forecast above.
The management team's strategy is to move away from commoditized
services in which incremental competition can negatively pressure
utilization, pricing and margins and instead focus on becoming a
"one-stop" solutions provider to the largest unconventional
drillers, most of which are already HEK's customers. By doing this,
HEK can provide water, dispose of drilling fluids and also handle
solid waste on a nationwide basis to the largest E&P companies
in the US.
There is confusion among investors as to which EBITDA multiple
range this business should fetch. Some argue for the 4x - 5x that
oil services fetch, while others argue for a multiple range more
aligned with logistics and waste management service companies, 6x -
7x. We agree with the latter, as it is plainly obvious that the
company's business model and margin profile is much closer to an
environmental waste handling businesses, but we acknowledge that
the company's end market is of course related to the former group.
Over time, the evolution of the business model, customer base and
contracted nature of customer relationships will, we believe,
result in a higher multiple being afforded to the company.
That fact, coupled with a strong organic and acquisition-led
EBITDA growth profile could well mean that the shares trade to a
level of $7.00 - $8.00 within the next few years. We acknowledge
that this investment is not a classic value play, but the upside
potential that comes for free at the current valuation is too
powerful to ignore.
I am long [[HEK]]. I wrote this article myself, and it expresses my
own opinions. I am not receiving compensation for it. I have no
business relationship with any company whose stock is mentioned in
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