Bronco Drilling Company

 

BRNC:  02/15/2007

 

Price: $16.25

 

Bronco Drilling is an oil and gas land driller based in the Texas/OK/Gulf Coast region of the country.  They have approximately 60 or so drilling rigs, of which 50 or so are currently operational – mostly for natural gas.  They also acquired a well svcs division.

 

Upside:

  • The stock seems overwhelmingly undervalued compared to the underlying fundamentals.  It is a classic “growth” stock profile – small company growing revenues, assets and margins at a rapid pace and reinvesting all cash flow into the business – but priced as a damaged “value” stock.  The market seems to have discounted it due to weakness in the natural gas sector in North America.
  • The company is very close (1.2 P/B) to its book value ($13.63).  This provides a floor for the stock price; a raider could theoretically buy the company’s shares and liquidate assets at a profit, provided the company is solvent (see next point).
  • Low debt load – the company’s debt is relatively low and can be paid back by cash flow.  No current prospects of bankruptcy (which would be total loss).
  • Long-term sector fundamentals – while I believe that energy is in a long-term bull super-cycle whatever, the FACTS stand that natural gas production is in a “running-to-stand-still” state in North America.  More wells have to be drilled to keep production steady (NOT GROWING, STEADY!).  That’s good for drillers.
  • While I am not an expert on the industry, the company seems to have resources for a small-sized company – including yards and resources for in-house refurb.
  • Possible upcoming catalysts – a bad hurricane season may be on the books if a La Nina system develops in the Pacific.
  • Diversified client base and moving towards diversified income streams with their well services division (even if companies are not drilling new wells, the existing wells need to be maintained – hence, well services).

 

Dangers

  • Oil Services is historically brutal and cyclical.  It may be different this time but the fact is that there is some softness in the North American market right now and day rates and utilization rates are falling.
  • A good number of rigs are of the lower horsepower, less attractive variety.
  • Falling natural gas prices will reduce demand for their services.
  • Smaller company may have a hard time withstanding a severe industry downturn.
  • Very little competitive advantage / no moat – supposedly, their expertise and customer service attention will allow them to hang onto clients.
  • No international exposure where demand for drilling is still strong and growing.

 

The Reasoning:

  • It’s rare that you see such compelling growth potential but valued as a complete dog-on-the-edge-of-bankruptcy-&-government-investigation, please-take-it-off-our-hands stock, esp. in a field that on a macro level, can only grow (Peak Oil).
  • While the oil svcs industry is historically cyclical (meaning highs are really good and conversely, lows are pretty brutal), industry scuttlebutt has revealed that the industry massively consolidated in response to the last down cycle and the next downturn should be more easily weathered.  Of course, the nature of downturns may be altered as peaking natural gas production becomes a recognized reality.
  • Slow times are now upon BRNC but they should easily be able to weather it despite their small base.  They are highly profitable with net margins around 20% and revenues growing over 200% for the last two years running.  They also have a downturn strategy in place (suspend refurb, shift toward less cyclical well-servicing, take rigs off-market to support prices) and appear to be executing.  The story of this company reads like this: if they don’t go out of business, we are going to make at least 25% ($20.00 target price) on our investment.
  • This company is strong by every measure (fiscal workout, estimate targeting, Greenblatt EY/ROC, ROA, P/E, P/CF, P/S, etc) except by the DCF model because of negative cash flow due to capital expenditures (obviously since they are a new and growing business).
  • Good opportunities in the well services industry.  Most of future natural gas production will come from wells that have yet to be drilled.  This should strengthen well services.  In addition, the industry according to Harrison (BRNC CEO) is fractured and open.

 

Management:

  • Integrity: B. Frank Harrison, CEO: management team, from conference call, seem to be pretty open and frank.  They do give answers easily, including ones which aren’t bullish for their company.  In addition, in their investors packet, they sent multiple analyst reports INCLUDING DOWNGRADES.  B is only because of short time of familiarity
  • Past Performance: A. The company has grown revenues by 266% in ’06 and 256% in ’05.  Gross and net profit margins are growing at such high rates as to basically be ridiculous (over 2000%) to rely on for reliable future metrics.  These are to be expected in a strong growing company and they are executing.  They’ve also moved towards securing their supply chain by running their in-house refurb and machine shop.  This allows them to rush product (rigs) to market to take advantage of strong demand and/or shift focus when market changes.  Their expansion into well-services seems to be another step in the right direction.