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Enteq Upstream - Knowing the drill

Enteq Upstream PLC - Knowing the drill
Technology-driven growth

Enteq upstream (LON:NTQ) is a leading supplier of high-end systems and products for measurement while drilling applications in the oil & gas industry.

The company has issued a trading update for the half-year period to September 2019. The company reports that revenues are expected to be up +50% year-on-year, with adjusted EBITDA doubling for the period. These figures are ahead of previous management expectations.

The revenue figure demonstrates that Enteq continues to deliver growth well in excess of its end-market. In particular, Enteq benefited from large orders from China, which has been a target market for growth.

In this report we examine some of the growth drivers for Enteq in the coming years. They include:

Expanding technology base. The company is pursuing an ambitious strategy of expansion of its product portfolio. We examine some of the key developments in terms of in-house product developments, collaborations, and IP acquisition.

Expanding geographic reach. Within the North American market, Enteq products have established a strong reputation for robustness, reliability, and functionality. However, the company under-indexes outside of North America. The company has begun to pursue a strategy of greater geographic expansion (details p6), which has been delivering results, as demonstrated by the H1 trading update.

We provide a detailed breakdown of our growth expectations, in revenue terms, and how this translates into earnings, on pages 7-8.

Financials and upside for shareholders

We are forecasting revenue growth of 20% annually for the period to 2022e, and 28% growth in EBITDA. This drives a strong increase in earnings per share to reach 4.7 cents by 2022e.

The company also has a strong cash position, providing sufficient resource to finance additional growth opportunities, potentially increasing earnings growth beyond our forecast.

We consider a valuation based on 2022e EV/EBITDA multiples and conclude that this approach highlights 87% upside to the current share price.

Year end Mar 31 Current 2020 2021 2022
         
Revenue (US$M) 10.20 11.46 14.46 17.50
EBITDA (US$M) 2.45 3.56 3.75 5.23
EPS ( US cents) (0.2) 0.2 2.5 4.7
Net Cash 11.9 10.5 11.0 12.0
         
 

Enteq growing strongly, against a broadly flat market demand trend

Enteq revenue growth versus market trend
 
Source: Baker Hughes rig count, Enteq historic data, Proactive Research forecasts
 
 
 

Enteq products

Enteq designs, manufactures and distributes the sensors and systems that enable measurement while drilling (MWD) in the oil and gas industry. MWD allows O&G producers to perform directional drilling operations without having to stop to take measurements.

The following diagram shows a typical Enteq product.

 

A brief description of some of the main features are as follows:

 

Vibmon: This monitors downhole shock and vibration in real-time, enabling drillers to avoid costly downhole equipment failure.

Directional Interface Module: Handles the acquisition, formatting and telemetry of downhole data to the surface.

Directional Sensor Module: This unit incorporates accelerometers and magnetometers to provide temperature-corrected positional data using aviation specification components.

Pulser Driver and DC Drive Pulser: In a typical MWD system, data is transmitted to the surface using mud-pulse telemetry, as a system which encodes downhole data in pressure pulses through the drilling fluid (‘mud’). The Pulser Driver drives this system.

Other Enteq products include individual sensors and systems, and mechanical parts for MWD systems.

These systems are designed for highly demanding environments - temperatures up to 175°C, pressures of up to 15,000 PSI, and high levels of vibration and shock. Equipment failures downhole lead to costly delays in a drilling operation; therefore, equipment reliability is essential to customers, and is one of the key performance factors that Enteq products offer to customers. Enteq products are found on one-in-four drill rigs in North America today.

The horizontal drilling market

Horizontal drilling refers to drilling at a non-vertical angle and has become a major feature of the oil and gas industry. Reasons for using horizontal drilling include:

  • Hitting targets that cannot be reached by vertical drilling. This may be the case if a reservoir is located under an obstacle that makes drilling impossible or prohibited.
  • Draining a broad area from a single drilling pad. This can be applied where it is necessary to reduce the surface footprint of a drilling operation, to minimize the impact on the local area.
  • Increase the length of the ‘pay zone’ within the target rock unit. This is illustrated in the diagram below. This type of horizontal drilling, when combined with hydraulic fracturing, can dramatically increase the productivity of a shale formation
  • Improving the productivity of a fractured reservoir. This is done by drilling in a direction that intersects with the maximum possible number of fractures, usual at right-angles to the dominant fracture direction.

The following diagram illustrates the use of horizontal drilling to increase the ‘pay zone’.

Horizontal drilling to increase the 'pay zone'
 
Source: Geology.com

Horizontal drilling has become the predominant technology

Horizontal drilling has become widely-spread practice in the North America O&G industry. The following chart shows the percentages of vertical wells versus horizontal over the last decade.

Vertical wells versus horizontal - North America
 
Source: Baker Hughes data

The transition towards horizontal drilling in North America may be largely complete, but there remain strong driver in place for the horizontal drilling equipment market.

  • Growth in the total rig count
  • Growth in global markets outside North America
  • Horizontal drilling technology is a continuously evolving space. Companies that are able to remain at the leading-edge of technology have the opportunity to grow their share of the value chain.

We next consider some of the growth drivers that are specific to Enteq.

New products and new markets driving Enteq revenue growth

Ability of Enteq to grow faster than the end-market

We are forecasting 20% per year revenue growth (CAGR) over the period 2019a-2022e. This compared with our expectation for the North American drilling equipment market to grow at 2%.

Additional growth drivers for Enteq include:

  • Further penetration of the existing customer base through an expanded product range.
  • Expansion into different geographical markets.

The following chart shows our revenue growth expectation for Enteq for the period through to FY March 2022, split into main drivers.

Revenue bridge 2019-2022
 
Source: Proactive Research

International markets (meaning outside North America) account for 61% of global demand

We first consider the potential for geographical expansion. The company currently (2019a) derives 90% of its revenues from North America. The following chart shows the geographic breakdown for the O&G drilling equipment market globally.

Geographic demand for drill rigs
 
Source: Rystad Energy

Enteq growth drivers - International sales, new technologies

In January 2019, Enteq announced the appointment of Andrew Law as director of international sales. Andrew was previously at Schlumberger, and then at the oil and gas corporate advisory business of KPMG, and most recently served as global account director for Weatherford in the Far East and Australia. He recently obtained the status of Sloan Scholar at the London Business School.

The appointment represents part of Enteq’s strategy to expand its market reach outside of North America.

The strategy has already been producing results, with revenues increasing by 80% in the year to March 2019. These revenues include equipment for drilling for geothermal power generation, which also represents a new market segment for Enteq. Furthermore, in the trading update for the half-year to September 2019, the company highlighted that 30% of revenues came from China, driven by large new orders. We believe that expansion outside North America will continue to be a major driver for the group through to 2022.

New Technologies

Enteq is also pursuing a strategy to grow revenues by increasing its technology base and broadening its product offering. The following are some recent examples of new product initiatives:

PowerHop. In May 2019 the company launched its PowerHop system for wireless power and data connectivity downhole. This is described as a ‘game-changing’ technology, which provides seamless connectivity between the various sensors and data transmission systems in an MWD assembly. The PowerHop system can be integrated with third-party devices as well as Enteq devices.

At Bit. Also in May 2019 Enteq announced a collaboration with Well Resolutions Technology, based in Houston, to integrate their 'At Bit' technology into Enteq’s MWD solution. The At Bit system collects data closer to the actual drill bit (when compared with conventional technologies) to allow improved drilling efficiency.

Rotary Steerable Technology. In August 2019 Enteq reached an agreement with the technology division of Royal Dutch Shell to integrate Shell’s technology into the engineering and manufacture of a specialised rotary steerable drilling system. Rotary steerable systems are becoming a new standard for fast and efficient drilling of oil, gas and geothermal wells. They currently account for around 10% of the global directional drilling market (in oil and gas applications) and continue to gain share. The project may take up to two years to bring to commercialisation, and total investment of up to $3m, representing a significant investment for Enteq, but with the potential to materially increase revenue in future years.

We note that the company has a strong balance sheet position, with cash in hand to allow the company to make further technological developments and/or IP acquisitions as opportunities become available.

Revenue growth delivers a strong 'drop through' to profits

Earnings impact

We expect that the incremental revenues that we are forecasting in the coming years will have a strong ‘drop-through’ into profits. The following chart shows our revenue expectations, compared with the cost of goods sold, admin expense and depreciation to show how our forecast for increased operating profit will be realised.

Profitability Bridge
 
Source: Proactive Research

We are forecasting revenue growth of 20% annually over the period 2019-2022e. Against this, we are forecasting gross margin to reduce from 65% to 55%, driven by a mix shift towards equipment sales versus rental, and also due to an increased proportion of complete systems versus component sales. However, we are forecasting administrative cost growth below the level of revenue growth, and reduced depreciation expense. The net result is operating profit margin swinging to a positive level over the period.

Rental Revenue

Equipment rental revenues have been a significant driver of revenues in FY March 2019 and the current year. These revenues derive from sales of Enteq’s own equipment under rental agreements, rather than outright purchase, and this business model has helped the company to access additional customers. We believe that the absolute level of rental revenue is likely to peak in the current year March 2020, and then stabilise at a lower level. This is reflected in our capex and depreciation forecasts.

Earnings Growth

The growth in revenue and EBITDA drives strong growth in earnings per share in our forecasts. The following chart shows our forecast for Enteq’s EPS for the period through to 2022e.

EPS growth
 
Source: Proactive Research

We are forecasting constrained progress in EPS in FY Mar 2020 due to an elevated depreciation charge. Thereafter we are forecasting strong growth in EPS numbers.

Valuation approach - 2022 exit multiples, based on EV/EBITDA

Valuation

We consider the valuation of Enteq based on 2022e EBITDA exit multiples. In other words we ask: How would an investor value Enteq after the period-end March 2022, based on March 2022 EBITDA?

So firstly, we consider how comparable companies are valued currently, based on their last period-end EBITDA figures. There is no directly comparable peer group available, in the sense of companies that produce the same type of equipment. Direct competitors globally are either a division of a large conglomerate, or privately-held companies. So, we are using a selection of UK-listed engineering companies as our peer group. The following table summarises.

Selected peers
 
Source: Proactive Research

These are all calculated using the last reported year’s revenue, EBITDA, and net cash. The enterprise value (EV) is calculated as market Cap + net debt (or minus net cash). Where US$ or euro as used as reporting currency, we have translated at GBPUSD = 1.24 and GBPEUR = 1.13.

Enteq Upstream valuation on EV/EBITDA 2022

The following table shows the valuation for Enteq based on EV/EBITDA for 2022.

Enteq valuation potential
 
Source: Proactive Research

The table shows a potential 2022 share price of 66p if Enteq trades on a trailing EV/EBITDA of 8.0x. This would put Enteq conservatively towards the lower end of the range based on the preceding peer group table. Discounting the 2022 share price of 66p back to today, at a discount rate of 10%, we would arrive at a 2019 share price of 49.6p, or 87% upside to the current level.

Forecasts

The following tables summarise our forecasts

 

 

 

P&L
 
Source: Proactive Research

 

 

 

Balance Sheet
 
Source: Proactive Research
Cash Flow
 
Source: Proactive Research

Quick facts: Enteq Upstream PLC

Price: 14.25 GBX

AIM:NTQ
Market: AIM
Market Cap: £9.61 m
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