Whilst the day to day business might be complicated CAPD is broadly an equipment hire business and so there are very few factors that matter.
1)Make sure you have the right product
2)Make sure it’s in the right place
3)Make sure the utilisation rate is high.
4)Do not over-expand. Time and again a great hire business is brought low because management think last year’s sales growth will happen again this year and to avoid a missed opportunity buy more and more equipment, usually with debt.
1)My presumption is that with 99 rigs and 57 in use and new contracts being mentioned they had the right product.
2)Again new contracts being mentioned suggested that the rigs were in the right place or could be moved to the correct place. I have seen companies which had vans in Spain, but demand in the UK. LHD v RHD meant the vans could not be used. Equally drilling rigs whilst not fully mobile are mobile enough. It beats Oil Rigs or product that requires specialist transportation.
3)Utilisation was poor. The higher the % of rigs in use the better. I have had investments in many hire companies, from hotels to submersibles, depending on the industry a usage rate of 80-90% is good. Over 90% very good. Below 80% not good. Last year with 57 rigs in use and 99 rigs owned the usage rate was only 57.5% not good. But not hard to be better. But as before the new contracts meant a better, even if not good, utilisation rate and a drop through of profits. The big costs of the rig are the financing and the depreciation. Both happen even if the rig is sitting doing nothing.
I was expecting a blockbuster H1 2021 set of results and on first reading I got them;
The rig utilisation % has gone from 57% to 73% a massive improvement. (And you can make good money going from poor to average).
Revenue went up from $65.1m to $98.7m and PAT from $13.6m to $18.4m.
And the interim dividend is up 33.1%
But all is not as rosy as I had hoped.
In the report for H1 management refer to EBITDA numbers. Now to my mind either they are being stupid or I am.
EBITDA was a very special measure drawn up by John Malone to calculate debt he could put into buying a specific capital asset (cables in the ground) that he would not need to replace for 20 years.
As an acquirer of large capital assets, potentially through debt, that it then rents and depreciates over time, I cannot think of many companies for whom EBITDA is a more useless and misleading metric. Yes the D&A are set rates and actual capex can be flexed, but if you are not into the weeds of each rig and future capex needs (and shareholders do not get that information) then it’s a pretty good guide of management’s overall assumptions. Or management is not doing it correctly.
So a firm for whom EBITDA is irrelevant putting out EBITDA numbers, is for me worrying. (Though EBITDA is a useful measure for an investment fund - see later comments).
Alongside this the group has a basket of investments. I thought this was a clever way to keep the money in the business, until it was needed to fund capex. But as the group needs new rigs these investments are not being sold, but are instead seemingly being held as a small Venture Fund and the company is taking on large debts.
I do not like this for two reasons. 1 – If I wanted a venture fund in Africa I would go for a pure play, not a miner with a fund bolted on. 2- The rates the company is paying to borrow are very high. In what is essentially a commodity price based business high rates can get you scalped. I am not disputing that management may believe the rate they can get by investing beats the rate they have to pay to borrow, but if that is the case become an investment house and borrow the money for that purpose not to take the rig cashflow and use it to build an investment house.
The company has had to add 7 rigs to its existing fleet to meet current requirements and is talking of another 8 by year end. This is worrying as it does suggest a number of its existing rigs (at least 25 do not seem to have been touched in the last year) are not producing and are unlikely to be producing any time soon. As such they may be overvalued and the company is putting off recognising this to flatter the P&L figures. It would also make the asset based overvalued, flattering the balance sheet.
In order to fund these new rigs the company has gone from having net $5m in the bank to net $32.8m of debt. As I have said before these are high rates and this is with the current low LIBOR. If that starts going up this could be very painful fairly quickly.
The only corollary to this and it may exist is if the financing rates and deal are reflective of an initial special price. I have seen deals in the past where parts of it looked strange but it all made a lot more sense as a combination.
To be honest at the moment I think this is an undervalued rig hire company with a management that enjoys running an investment fund and I have no idea on whether the investment fund is over or under valued.
As such my initial feeling that the results were excellent and I should have bought more is now tempered by how much am I losing from the profit we could be making because management prefer running an investment company to running a hire company.
There is still I think, value here, but I have moved from yesterday’s thinking that I need to be buying to much more of a wait and see approach. If the shares fall enough I may buy. But at the moment given my reluctance to add if the shares rise enough I may sell.