Civeo ($CVEO) — Initiation (5/23/21)

I’ve followed this stock for years and have owned it in the past. I recently took another position with an intention to hang on for the ride.

Cliff notes version…

Civeo was a spin-off from oil services company Oil States International ($OIS) back in June 2014. Civeo followed oil prices down in 2014-2016 but never bounced back.

$CVEO vs. WTI spot price

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Civeo supports the energy and natural resource industries with workforce accommodations. They supply lodging, catering, and entertainment in remote locations mainly for oil production.

While earnings never fully recovered to 2014 or prior levels, the business remained solidly cash-generating throughout the oil downturn and slowly chipped away at debt to a point where they are now capable of using cash for other purposes (for the first time in post-spin-off history). Civeo has generated positive free cash flow every year from 2014-2020 and remains entirely focused on this metric.

As of 1Q21, a $16 stock gets you a $230m market cap with $230m in net debt. This is trading at 4-5x FCF and less than 5x EBITDA with ~2x leverage.

Background…

Civeo provides accommodations to remote workers in oil, gas, and coal mining operations in Canada, Australia, and the US. They offer lodging, meals, entertainment, etc. Think of it as a hotel or campsite resort in remote areas for oilfield workers. Here’s how they describe it:

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Civeo owns and operates 28 lodges and villages with 30,000 rooms and they manage another 9,000 rooms owned by customers (i.e. facilities management services). There are a mix of short-term rentals and multi-year contracts. Roughly 9,000 (30%) of rooms are under contract over the next 5+ years.

Customers use Civeo for different parts of the value chain — ongoing operations / production, maintenance work, and construction (i.e. new exploration). The latter piece has all but dried up over the past few years as commodity prices have not supported much new exploration. Civeo gets the bulk of its revenue from ongoing production with some occasional spikes from maintenance/turnaround activity.

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Segments are divided by geography:

  • Canada — ~19,000 rooms in this segment. Supports LNG and oil sands customers. Billed 2.1m days in 2020 at an average daily room rate of $95.
  • Australia — ~9,000 rooms in this segment. Supports miners of met coal (Fortescue Metals Group is largest customer). Billed 2m days in 2020 at an average daily room rate of $73.
  • US — 925 rooms in this segment. This is the smallest segment by far. They primarily offer mobile lodging in Permian, Mid-Continent, and Bakken regions.
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Civeo notes the industry is divided into 2 camps: 1) lodges/villages; and 2) mobile assets. Competitors have pushed heavily in the direction of mobile assets given their flexibility (they move!) but Civeo has significant sums already invested in their facilities. Pubic competitors each have between 10,000 to 14,000 beds under management compared to Civeo’s 39,000.

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So Civeo is a dominant player in the lodges and villages space which requires upfront investment in fixed assets. Competitors are heavily investing in mobile assets. Capex is minimal once the lodges are built since the largest outlay is to build the facility itself. There is amazing potential for operating leverage here — at ~30,000 total rooms x 365 days = 11m potential billable rooms per year… in 2020, they billed just over 4m rooms so 30-40% utilization while still maintaining profitability.

Civeo has been pushing into the facilities management offering as well which looks more like Aramark / Sodexo. They indicate that potentially 50% of the market is represented by customer-owned rooms. They’ll never trade at multiples like those companies given the exposure to energy and the fixed asset ownership.

Financials…

There are 14.2m shares outstanding x $16 stock price = $230m market cap. Net debt is $230m but should finish 2021 at $200m or less. Call it a $430-460m enterprise value.

Cash flow statement…

From 2016 to 1Q21, Civeo generated $315m in free cash flow (vs. current market cap of $230m). They spent $188m on acquisitions (one large deal: Noralta) and $187m went to repay debt. Some equity was issued during this period to clean up the balance sheet and in tandem with the Noralta acquisition.

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Segment financials…

  • Revenue has grown over the past few years but primarily from the Noralta acquisition in late 2017 and Action in AU which was acquired mid-2019.
  • EBITDA margins have consistently been around the 20% level.
  • US segment has been inconsistent and operating around breakeven for years.
  • Australia segment saw a pickup in 2020 thanks to an acquisition in late 2019.
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2021 guidance calls for $555-580m in sales, $90-100m in EBITDA, and $50-65m in free cash flow. That’s less than 5x EBITDA, 4x free cash flow, and leverage of 2.4x.

Management has been incredibly focused on generating cash for years now and they have a good feel for the business at this point. They’ve telegraphed free cash flow for 2021 to be $50-65m:

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With $16m in FCF during 1Q21, that should leave another $35m or more for the remainder of the year. Net debt sits at $230m so we should cross below the $200m mark by end of year unless cash starts going toward buybacks.

Capex has fluctuated over the years as growth projects have come along. These haven’t always translated into meaningfully higher cash flow but management has been very selective in spending cash. Maintenance capex runs less than $10m per year.

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Why own it…

This company has nearly always been cheap on a price to free cash flow basis. The debt load has always been high and the concern around the longevity of oil production lingers.

Recently, what turned me on to the name were twofold — first, debt has reached management’s targeted comfort level of 2-2.5x; second, for the first time, they are indicating that cash could be used for purposes other than repaying debt.

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I’m clearly attracted to the consistent cash generation here but I think there’s some quality in the business that’s easily overlooked..

  • The Australian segment is an absolute gem… having produced $175m in EBITDA over the past 3 years and requiring only $13m in capex on a $280m asset base — that’s dang near 20% ROIC within that segment alone. Despite an ongoing trade dispute with China on coal, the Australian coking coal industry has been very stable.
  • The Canadian segment is mostly tied to oil sands which has attractive dynamics — they have large reserves and low cash costs once mines are up and running. Canadian oil sands producers like CNQ, Suncor, and Imperial aren’t walking away from these production streams anytime soon.

Other lodge operators are trading at 7x EBITDA or more while Civeo is hanging around the 5x level. There are some reasons for this. Black Diamond gets half of its revenue from faster growing modular solutions (i.e. mobile assets); Target Hospitality has a third of revenue from non-energy related sources; and Dexterra just completed their merger with Horizon North and are on a path to $1bn in revenue and $100m EBITDA.

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As recently as March 2020, from the Dexterra/Horizon investor deck, they were calling out Civeo as a comp trading at 6x EBITDA…

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A 6x EBITDA multiple for Civeo today would mean a $24-26 stock price or 50-60% higher than today’s price…

With the remaining $35-40m in FCF during 2021, I see management taking debt below $200m — this would take the EBITDA multiple down to 4.5x. Beginning in 2022, I think it’s likely they’ll take a balanced approach to managing debt and repurchasing stock — a split of $25-30m toward buybacks and $25-30m toward debt would take down 10%+ of shares each year and knock off 0.25x leverage. Take that scenario out 3 years (to 2024) and you have 10m shares outstanding and $125m in debt — that’d be $5 per share in FCF or 3x!

There are still risks to the story. The Australia - China trade dispute could dampen mining activity for the AU business. Canada has been spotty over the years but oil prices have settled in and the oil sands companies have been consistent. But make no mistake, Civeo is 100% exposed to oil prices and met coal prices. Also, these are mostly fixed structures and require continued activity in the regions Civeo has exposure to (again, think hotels or resorts).

Overall, commodity prices are in good shape as of 1Q21.

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Risk / reward looks amazing at $16 with a fairly easy path to $20-30 and potentially more as they shift capital allocation. They are already raking in ~$3.50+ per share in FCF and should be able to grow that figure significantly over the next few years.