Enteq Upstream - The SABER's edge
We argue that Enteq Upstream is well-positioned for robust performance in FY (fiscal year) March 2022 and strong growth thereafter. The company recently released a trading update for FY March 2021 confirming that results are in line with previous management expectations. In this report, we present a detailed analysis of the company’s position within the oil & gas equipment market, and the financial outlook.
From a shareholder’s perspective, important aspects of the investment case include:
- A successful strategy of entering new geographic markets.
- A pipeline of new products that substantially expands the addressable market.
- A strong net cash position.
In terms of new products, the most important development is the SABER Rotary Steerable System (RSS), which extends Enteq’s position in the geosteering market and increases the addressable market from US$100mln to US$2bn. Field testing of the RSS will take place in 2021 and we believe that first revenues could be achieved as early as the coming financial year.
The other major driver is a continued expansion of the company’s geographic customer base outside the traditional core North American market. This process started in 2019 under the direction of commercial director Andrew Law, who became group chief executive officer (CEO) in April 2021. During FY March 2021, Enteq has derived significant revenues from China that have helped to mitigate the sharp slowdown in US oil & gas (O&G) capital expenditure (capex). The company has further expansion opportunities in Russia and surrounding areas and the Middle East, with a material new project in Saudi Arabia potentially advancing to the revenue stage during 2021.
Resilience and growth
Results for the financial year ended March 2021e will reflect substantial revenue pressure due to pronounced weakness in O&G capex; however, Enteq has responded with significant reductions in operating costs, and we believe that the company is on track for an outcome close to break-even at the EBITDA (underlying earnings) level.
Furthermore, the company retains a strong net cash position and has sufficient resources in our view to trade through the current industry downturn and continue financing growth projects.
In terms of valuation, the current enterprise value (market cap net of cash position) stands at US$8mln and we argue that this does not reflect the company’s medium-term revenue potential. We believe that successful progress during FY Mar 2022e, in terms of export contracts and RSS development, could serve as catalysts for the significant re-rating of the shares.
Financials
Year end Mar 31 · 2019 · 2020 · Current · 2022
Revenue (US$M) · 10.2 · 10.9 · 5.2 · 6.5
EBITDA (US$M) · 2.5 · 3.1 · (0.1) · 0.6
Net Cash · 11.9 · 10.2 · 8.1 · 4.4
Enteq Upstream is an O&G equipment provider with a strong financial base and a pipeline of transformational growth opportunities that represent substantial upside potential for shareholders. Key attributes include:
- A recent record of global market share gains via geographic expansion, with substantial opportunity for continued growth.
- New products entering the market that significantly extend the addressable revenue base.
- A strong net cash position and reduced cost base allow the company to sustain operations through the current constrained industry capex environment and exploit opportunities to invest for further growth.
The Enteq product range addresses a growing imperative in the oil and gas industry – maximising well productivity using directional drilling and geosteering technologies.
The directional drilling market
Directional drilling refers to drilling at a non-vertical angle and has become a major feature of the oil and gas industry. Reasons for using directional 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 minimise 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’.
Investment summary
Directional drilling is an increasingly important technique in O&G production
Directional drilling to maximize the 'payzone'
Source: Proactive Research
Enteq designs, manufactures and distributes a range of sensors and systems for downhole use in directional drilling applications. The main product categories are:
Measurement while drilling (MWD)
MWD technologies have historically been the bread-and-butter for Enteq Upstream, and remain an important driver of revenues and growth.
These technologies provide well operators with real-time data from downhole, including position and direction of the drill bit, as well as temperature, vibration and gamma radiation levels. The systems are highly ruggedised to withstand temperatures of up to 175˚C and pressures of over 120MPa as well as high levels of vibration.
Logging while drilling (LWD)
Logging while drilling provides the well operator with additional data, such as the electrical resistivity of the rocks. Basic information can be received at the surface in real-time. Enteq integrates with LWD systems from third-party partners to offer a solution to customers.
Downhole connectivity systems
There are a lot of difficulties associated with transmitting data between modules within the MWD and LWD systems. Enteq provides a range of technologies to allow these systems to communicate.
New products significantly extend Enteq's range of capabilities
New product range – At-Bit System
Through a collaboration with a company called Well Resolutions Technology, Enteq can offer a range of At-Bit tools which combine with the MWD system to provide data from as close as 30 cm from the drill bit (traditional sensors are located further back along the drill string), providing real-time geological data such as radiation and resistivity readings. This can enable real-time geosteering.
New product range – SABER (Steer At Bit Enteq Rotary) Rotary Steerable System (RSS)
Unlike Enteq’s other products, which use various elements of downhole electronics to take passive measurements, the SABER Rotary Steerable System is a physical steering system with integrated electronics, which allows the operator to adjust the direction while drilling is ongoing. The RSS will greatly increase Enteq’s addressable market, and we provide some details on p5.
The following diagram illustrates some elements of Enteq’s product range.
Illustration of some of Enteq's products
Source: Enteq Upstream
The O&G equipment market has been depressed during the past 12 months due to reduced end demand for hydrocarbons. We expect some degree of recovery in capex during the next 2-3 years; however, most of our growth expectation for Enteq Upstream comes from market share gains driven by new products and continuing geographic expansion for the company.
We argue that Enteq offers a compelling growth investment, with a strong financial base, and a currently depressed valuation as an entry point for shareholders.
Expanding the opportunity - new products
The biggest growth driver for Enteq Upstream in our view comes from the introduction of new products.
SABER takes Enteq into advanced electromechanical components
The most important new product is the SABER Rotary Steerable System (RSS), which is currently entering the final stages of its development. The technology was acquired under a licence agreement with Royal Dutch Shell in 2019. This product takes Enteq from being a pure electronics measurement player into advanced electro-mechanical systems. The RSS allows a well operator to steer the drill bit while continuing to drill, in contrast to traditional directional drilling techniques that require time-consuming cessation of drilling to redirect the bit.
The SABER RSS system will enter field testing during the calendar year 2021, with the potential to begin generating revenues during the upcoming financial year FY Mar 2022.
The Enteq RSS has two important advantages compared with steerable systems that are already in the market place:
- Fewer moving parts, offering greater reliability
- Enteq’s status as an independent equipment provider
The following schematic illustrates the competitive landscape:
Only two independent equipment providers offer RSS technologies
Rotary steerable system - the competitive landscape
Source: Proactive Research
Enteq’s status as an independent represents an important differentiator – oil service companies who compete with Schlumberger or Baker Hughes would prefer to source an RSS from an independent rather than from their competitor. The only other independent provider is D-Tech.
The geosteering market
Geosteering is a type of directional drilling that uses geological readings to optimise the path of the drill hole as it progresses, as opposed to conventional directional drilling which follows a pre-determined path.
The Enteq MWD product range serves the whole directional drilling market, with particular utility in geosteering applications. The newer products such as the AtBit systems and SABER RSS further extend Enteq’s reach in the geosteering market.
The following diagram illustrates the current product (MWD) market versus the expanded opportunity (RSS) and the wider geosteering market which could be addressed with further product developments or technology acquisitions (not included in our forecasts).
Enteq is evolving from a MWD-focussed company to a geosteering technologies provider
Expanding the market opportunity
Source: Proactive Research
Geosteering is not only a large existing market opportunity, but is also continuously growing. The following diagram illustrates the trajectory of the geosteering market.
The geosteering market has strong growth prospects
The geosteering market
Source: The Insight Partners Analysis, commissioned by Enteq
We believe that Enteq has the potential to continue building market share within this growing segment based on the company’s expanding product offering.
Expanding the opportunity - geographic markets
Aside from the expanded product range, the other major growth opportunity for Enteq is the continued expansion of its geographic customer base. As of FY Mar 2019, the company derived 90% of its revenues from North America. In January 2019 Enteq appointed Andrew Law (now CEO) as director of international sales, with a mandate to expand into new geographies.
The decision to internationalise the revenue base has turned out to be a timely move for Enteq, as the O&G capex contraction in 2020 following COVID has been particularly acute in North America compared with other geographies.
The following chart shows the geographic mix of Enteq’s own revenues, with sales to China expanding particularly strongly.
Enteq geographic expansion
Source: Enteq Upstream data
We believe that the next major growth targets for Enteq are Russia and surrounding areas, and the Middle East. Within the Middle East Enteq currently has equipment undergoing certification with a strategic partner which provides services to Saudi Aramco.
We expect growth in the Middle East, Russia, and China to contribute significantly to group revenues in the coming years.
Current trading - virus impact on the O&G equipment market
The O&G equipment market suffered a sharp downturn in 2020 due to demand erosion as a result of COVID-19. The effect was particularly acute in the North American market. The following chart illustrates the decline in active rig count in North America in 2020.
Activity in North America has shown a recovering trend, notwithstanding the seasonal dip in February
North America rig count
Source: Baker Hughes
The weak rig count in mid-2020 also led to surplus equipment available in the market, adding to the squeeze on demand for new equipment; however, the rig count has begun to improve since mid-2020, and in spite of a seasonal dip in February (following the pattern of the previous years) we believe that the trend is now clearly beginning to improve.
Although expansion into overseas markets has provided some mitigation for Enteq, the collapse in North American demand nonetheless contributed to a very challenging revenue environment for the company during FY March 2021.
In response to these conditions Enteq has implemented a rapid reduction in operating costs. The following chart show the reduction in overheads over the period.
Enteq has delivered significant cost reductions
Enteq overhead costs - 6 months trailing data
Source: Enteq Upstream data
With a strong net cash position remaining on the balance sheet (see p8) and with the benefit of the cost reductions, we believe that Enteq is well-positioned to trade through the current downturn and continue investing for growth.
Financial outlook
Taking account of the depressed revenue environment and also the effect of cost cuts, we expect Enteq to trade close to break-even for FY Mar 2021 at the EBITDA (Earnings Before Interest Tax Depreciation and Amortisation) level.
From the FY Mar 2021 trough level, we expect EBITDA to recover into positive territory and grow strongly in the next 2-3 years. This is based on broadly flat gross profit margins, with increased absolute levels of revenue and gross profit driving improved EBITDA margins through operational leverage.
The following chart illustrates our profit forecast for FY Mar 2021 and 2022.
We forecast increased revenue and gross profit in FY Mar 2022, driving EBITDA back to positive figures
P&L metrics
Source: Proactive Research
In terms of the adequacy of Enteq’s net cash position, we argue that recent levels of cash utilisation are comfortably sustainable in the medium term. The following chart shows the evolution of Enteq’s net cash position.
Balance sheet progression
Source: Proactive Research
In FY Mar 2022e we expect some increase in cash utilisation (full forecasts p10) driven by increased investment in RSS as it moves through the final stages of its development. We nonetheless expect the company to retain a comfortable positive net cash position.
Conclusion
The current enterprise value of Enteq Upstream (market capitalisation minus net cash position) stands at ##US$8mln. We argue that this valuation does not reflect the strong medium-term growth potential of the company. Our growth expectations are underpinned by:
- Continuing growth in the geographical customer base
- An expanding product portfolio
- Financial resources to continue pursuing growth opportunities
We believe that further progress on the SABER RSS and international contracts during the calendar year 2021 could act as catalysts for re-rating of the shares.
Financials
Source: Proactive Research
Source: Proactive Research
Source: Proactive Research