Equity research: Tuscany International Drilling, Inc. (Part 1 of 4)
Tuscany International Drilling, Inc.
Tuscany International came onto the Toronto exchange in 2010 with a niche market–focused entrepreneurial team that had a successful industry track record. A number of setbacks have caused the stock to materially underperform, but the company seems to be gaining traction as it works through these problems and management looks determined to deliver results. Significant catalysts should be surfacing within the next few quarters, and in the event catalysts do not play out as expected, the asset base provides a cushion that should skew the risk/return profile to 100% to 200% upside, 30% to 50% downside.
Tuscany International is a provider of onshore drilling and workover services to the oil and gas industry, with operations primarily in Africa and South America, including Columbia and Brazil. Petroleum exploration companies such as Petrominerales hire Tuscany for equipment, expertise, and drilling services. Contracts are negotiated on duration and price, and thus profits are often analyzed based on number of rigs owned, how many are contracted, how long the contract will last, and the price per day an exploration company will pay for services.
An ideal scenario for firms such as Tuscany is to have many rigs contracted at 100%, all of which are in long-term negotiations with high day rates. This was basically the bull case sold to investors in 2010, which continued for roughly a year. But alas, contracts don’t last forever and renewal can take time, some are terminated early, day rates sometimes decline, and operating in emerging markets can heighten each of these risks. Unfortunately, during 2012, Tuscany became prey to all of the above, as utilization rates declined from high 80% to middle 60%, average day rates trended downwards from 30s to low 20s, and customers terminated contracts early.
For conservative firms, these issues can be viewed as a frustrating part of normal operations. Management, however, overleveraged Tuscany and the situation quickly turned dire. Quarter after quarter throughout 2012, revenues and profits declined, canceled contracts turned into lawsuits, and Tuscany looked ever closer to having debt servicing troubles. The stock hit its lowest level at $0.10 in April, as investors basically deemed the company insolvent.
The Market Realist Take
In 2Q 2013, the company recorded a net loss of $9,741 compared to net income of $1,269 during the same period in 2012. It said that decreases in revenue, adjusted EBITDA, and gross margin for the second quarter of 2013 compared to the second quarter of 2012 reflect a 10% decrease in operating activity and a 6% decrease in average revenue per day. This was as a result of rigs coming off contract in the second half of 2012. It expects sales of $72 million and an EBITDA of $14.73 million for 3Q 2013.
For 2Q 2013, gross margin was $23,062, or 32.1%, compared with a gross margin of $26,128, or 30.7%, for 2Q 2012. For the six months ended June 30, 2013, gross margin was $39,417, or 30.1%, compared with a gross margin of $57,498, or 32.0%, for the six months ended June 30 2012. The increase in gross margin percentage for 2Q 2013, compared to the gross margin percentage for the three months ended 2Q 2012, is primarily due to three rigs in Colombia being contracted at lower day rates. These lower day rates were more than offset by contract terms that provide that the majority of the operating costs are borne by the customer, resulting in higher gross margin percentages. The decrease in gross margin percentage for the six months ended June 30, 2013, compared to the gross margin percentage for the six months ended June 30, 2012, is primarily due to costs incurred in the first quarter of 2013, associated with rigs that came off contract during the latter part of 2012.
Compared to North American markets, international drilling markets are less cyclical. Volatility in commodity prices influences the performance of drilling and oilfield servicing companies. The companies outperform or underperform the market when commodities rise or fall. Day rates, and therefore drilling revenue, mirror commodity prices. This is because onshore drilling contracts are likely to be short-term in nature, with some contracts negotiated on the spot market. According to the OPEC (Organization of the Petroleum Exporting Countries) Monthly Oil Market report for September, “Commodity prices were largely flat for the month. Energy prices, which have risen by around 15% to August since the trough in mid-April, have hardly changed in September — with the exception of natural gas — after geo-political concerns are fading and temporary supply disruptions have been overcome recently.”
A recent article on Market Realist, Must-know: Why oil prices dropped on API inventory data, explains that for most of this past year, WTI crude oil has been range-bound between ~$85 per barrel and ~$110 per barrel. Higher crude prices generally have a positive effect on stocks in the energy sector. Oil prices affect the revenues of oil producers, and consequently affect the amount of money oil producers are incentivized to spend on oilfield services. Recent downward movement in the prices of WTI Crude was a negative for the sector. However, oil prices over the past few months have largely remained elevated above $100 per barrel, which is a medium-term positive. The spike in oil prices and strong international drilling operations seems to have benefited the major players like Schlumberger (SLB) and Baker Hughes (BHI), which has reported profits in its recent earnings. But analysts believe Tuscany is facing challenges with respect to its balance sheet and currently seems to be in survival mode.
Tuscany has a major share in Colombian and Brazilian drilling markets and plans to exploit the vast opportunities in the new hot oil spots globally on the footsteps of the major drillers like Weatherford (WFT), Superior Energy Services (SPN), Calfrac (CFWFF), , Halliburton (HAL), and Key Energy Services (KEG). Its competitors include Calmena (CEZ), Nabors (NBR), Helmerich & Payne, (HP), Forbes Energy (FES), and Ensign Energy (ESI).
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