ESOA - Energy Services Corporation of America

[Guest Schwab711]

Background: ESOA was a SPAC that was founded in 2006. The acquisitions of Nitro Electric Company, ST Pipeline, and CJ Hughes Construction were announced in 2007-2008. Ultimately, ESOA honored the agreements with each of the companies and the three combined companies created ESOA. (Note: the CJ Hughes transaction was a related party transaction, though it appears as if a fair price was paid relative to similar companies in 2007 [when price was agreed upon]). Upon the completion of the transactions, a Mr. Edsel Burns was placed as CEO from 2009-2012 (he was president in 2008). Marshall Reynolds (current chairman and current CEO's father) was the CEO at the time the deals were struck. He had an interest in CJ Hughes at the time of the acquisition. He has never sold a share since the original transaction. Mr. Burns ended up being a pretty poor operator and oversaw some aggressive accounting. ESOA took a bath on their sale of ST Pipeline, Mr. Burns was let go of, and Doug Reynolds (Marshall's son) was installed as CEO. Currently, Marshall is chairman, Doug is CEO, and another son (Jack) is a director. Overall, you can safely assume there are no true independent directors. This is not necessarily something uncommon with OTC companies (though the nepotism is more than I'm used to) but should definitely be considered.

 

Doug Reynolds: This guy is genuinely impressive. He is a bright guy that was a founding partner of a WV law firm and a Delegate of the West Virginia House of Delegates (first elected at 31). He also previously served as a public defender in Cabell County (WV-OH-KY region). Doug also sat on the energy committee and ran on a platform of moving WV away from coal and towards natural gas. ESOA will continue to benefit from this shift.

 

He took over as CEO of ESOA in 2012. He helped get a forbearance for the company and find investors for a preferred investment. The terms of the preferreds is 6% dividend + convertible at $1.50/share (was trading at $0.50 when preferred negotiated). The Reynolds' Family would have been better off letting ESOA go bankrupt and to purchase the assets at that point. Since the preferred deal, the company has not diluted shareholders and the business has improved substantially. Doug helped reduce Debt/Equity from 500% to 50%, presently.

 

Current Ownership:

Marshall Reynolds - 10.1%

Doug Reynolds - 9.4%

Most of the director own 1% - 3% each

GRT Capital - 6.6%

 

Trends/Future Outlook:

CJ Hughes and Nitro both seem to be strong competitors for <$5m jobs in the WV-OH-KY region. I don't know a ton about construction but, combined, the two entities seem to have fairly high market share on electrical distribution, pipeline (for power plants and energy companies), and commercial electrical contracts.

 

Valuation:

Share Price: $1.66

MC: $23.6m

Cash: $7.0m

LT Debt: $11.0m

EV: $27.7m

 

EBITDA: $10.5m

EBIT: $7.9m

EBT: $6.8m (includes other non-operating expenses, not gain on sale of assets)

*Effective tax rate has been 43% to 47%. ESOA would benefit greatly from Trump's recent tax plan.

NI: $3.47m

Adj NI: $4.45m (@ 35% tax rate; also includes non-op exp but not gain on sale of assets)

FCF: $9.2m

Normalized FCF: approx $7.5m

 

At Present Multiples:

EV/EBITDA: 2.6x

EB/EBIT: 3.5x

P/E: 8.4x

Adj P/E: 5.3x (only adj is tax rate)

P/B: 1.0x

P/FCF: 2.3x

 

With Pfd Dilution (24.11% dilution; $309,000/yr saved in pfd divs):

MC: $29.3m

EV: $33.4m

 

EV/EBITDA: 3.2x

EV/EBIT: 4.2x

P/E: 7.7x

Adj P/E: 6.6x

P/FCF: 3.2x

P/Normalized FCF: 3.9x

 

Edit: For reference, there are 35 companies in the oil & gas services industry that have > $0 TTM EBITDA. Of those companies with EV < $1b, the median EV/EBITDA multiple is 10x - 11x. The construction/energy services industry has been bombed out. Of those 35 companies, ESOA has the highest margins and returns, over TTM period. If ESOA can continue to win contracts at their current rate, a 8x EBITDA multiple probably isn't crazy. Taking some discount for liquidity and nepotism, I think 6x - 7x EBITDA is reasonable. The current middle market multiple for companies between $25m - $250m is 8.0x EV/EBITDA.

 

Summary:

Overall, ESOA is not the greatest business ever, but it's cheap with some potentially good tailwinds (Corp tax reform, prioritizing infrastructure spending, or general natural gas pipeline/power plant/refinery activity in the WV-OH-KY region). I think management has a history of looking out for shareholders (Marshall Reynolds is an interesting figure to research) and is generally against dilution. Doug Reynolds has outstanding connections, intelligence, and has thus far done well at converting this into profitable business. ESOA is also one of the few profitable companies in the energy services industry since the decline in energy prices. After the re-cap and prioritizing LT debt repayment, ESOA is in much better shape than their peers at the moment. I like my odds with this one.

[maybe4less]

I'm intrigued. What do they do with their cash flow? Looks like they reinvest most of it?

[Guest Schwab711]

They have paid off a roughly $20m of net debt over the past 4 years. Currently, net debt stands at ~$11m. I would guess they would be looking to increase the dividend over the next few years. Marshall Reynolds is a long-time banker and mentioned he prioritizes returning capital to shareholders, where possible. Despite the price, I would guess we will not see share buybacks since liquidity and float are fairly low. So basically the same as 2015, but the shift towards more dividends and less debt repayment over time.

 

The business is also fairly cyclical so this will probably not be a smooth ride to the promised land. I think the next few years look promising, though.

[Guest Schwab711]

ESOA is almost certainly going to exceed my normalized OCF estimate this year.

 

http://www.otcmarkets.com/edgar/GetFilingPdf?FilingID=12101677

[KJP]

ESOA is almost certainly going to exceed my normalized OCF estimate this year.

 

http://www.otcmarkets.com/edgar/GetFilingPdf?FilingID=12101677

 

Thanks for posting this idea and following up about it.  A few questions:

 

1) In your initial post, you provided various "FCF" metrics, which I assumed referred to free cash flow.  But I cannot reconcile your FCF numbers to the company's historical numbers.  Are your figures just picking up the big positive working capital change in Q1 or were your referring to operating cash flow, as you appear to do in what I quoted above? 

 

2) How did you arrive at the "normalized FCF" estimate in your initial post?  On a first read through the last 10-K, I did not see any reason why, over time, this company should produce FCF that is substantially higher than its net income.  I would expect FCF to lag net income over time.

 

3) The company pays state income taxes and its GAAP financials include expenses that are not fully deductible for tax purposes (see footnote 11 to the 2016 10-K).  So, under current tax law, is there any specific reason to believe that its effective tax rate will fall below the low 40's? 

 

4) Who actually runs this business on day-to-day basis?  As you noted Doug Reynolds was a member of the West Virginia Legislature, ran for AG in 2016 and still has his own law practice.  So I don't think he has time to actually run the business on a day-to-day basis.  He was also paid less than $100k in 2016, so he's not paid like a full-time CEO either.

 

5) The company's annual insurance premiums are material relative to its net income.  It pays those premiums to a captive insurer.  Have you looked at whether the premiums it's paying to the captive are similar to what other companies in the industry of similar size pay to third-party insurers?