Durig Fixed Income Bond Review
Entrec Corporation, ~12.7% Yield-to-Maturity, Matures June 2021
(all figures quoted are in CAD dollars)
This week’s bond review focuses on a Canadian company that is a key player in a niche industry with high barriers to entry. Entrec Corporation is a heavy haul transportation and crane company providing service to the oil and natural gas, construction and power generation industries, among others. The company recently released its first quarter 2017 financial results, which showcase a company that is beginning to excel again after historically low oil prices.
Revenue increased 22% year-over-year to $37.3 million from $30.6 million.
Adjusted EBITDA was up an astonishing 64% as compared to Q1 2016.
Adjusted EBITDA margin also increased to 6.1% from 4.6% in the prior year period.
In addition to increased revenues from its U.S. based operations in Q1, Entrec’s May 2016 acquisition of HighMark Crane has presented additional opportunities for the company in the power transmission, mining and commercial construction industries across Canada. In order to provide balance sheet flexibility, the company amended the terms of these convertible 2021 bonds in 2016, reducing the conversion price from $2.60 to $1.00 per share and extending the maturity from 2017 to 2021. These 8.5% couponed bonds, denominated in Canadian dollars, are currently selling at the discount price of about 87, giving them a yield to maturity of approximately 12.7%. For savvy investors, adding an investment from the heavy haul sector can provide additional diversification and may help to increase portfolio return. In light of these factors, we have chosen these Entrec bonds for addition to our FX2 global high yield income portfolios. The most recent performance of our managed FX2 portfolio is shown below.
About the Issuer
Based in Alberta Canada, Entrec Corporation is a heavy haul transportation and crane solution provider to the oil and natural gas, construction, petrochemical, mining and power generation industries. Operating from 14 locations throughout western Canada, North Dakota and Texas, the company currently employs approximately 500 employees and operates a fleet of cranes, multi-wheeled trailers, and tractors, as well as lines of specialized platform trailers. Its crane fleet consists of rough-terrain cranes, mobile cranes, crawlers, carry decks and picker trucks. Its tractor and trailer fleet consists of tractor units, winch trucks, and a wide range of conventional heavy haul trailer units. Entrec’s customer list includes many large multinational oil and gas producers such as Chevron, ConocoPhillips and Husky Energy. Entrec has two major shareholders: JV Driver Corporation with 20.5% stock ownership and Manitoulin Transport with 19.6% ownership. Entrec is one of the market leaders in a niche industry with high barriers to entry.
(Source: Entrec Presentation, May 2017)
Managing the Business During Oil Price Volatility
As Entrec has primarily serviced the oil and gas industries, it, like many companies deriving revenues from oil and gas, has made adjustments in its operations since mid-2014 to better weather the historically low oil prices seen in the past few years. And although oil does appear to be on its way to recovery, management at Entrec has adopted a three pronged approach to maintain its competitive position as well as to be ready for growth when the time comes. The company’s three initiatives are to 1) grow sales through diversification and aggressive sales efforts, 2) maintain a secure financial position and 3) cost reductions.
Growing Sales Through Diversification
From its beginning in 1995, Entrec got its start providing services in the oil sands region of Alberta, Canada. Since that time, the company has expanded into British Columbia with its oilfield services. In taking steps to diversify, both in location and in industries, Entrec made a few shrewd moves in 2016 that are paying off. First, Entrec acquired HighMark Crane, a crane operator specializing in providing services in the power transmission, mining and commercial construction industries across Canada. HighMark had a strong reputation as leading provider of crane services to the power transmission industry all across Canada. With this acquisition, Entrec is now able to expand its operations into the provinces of Manitoba and Newfoundland & Labrador. This positions Entrec to win contracts for large commercial construction and infrastructure projects across Canada.
(Source: Entrec Presentation, May 2017)
Also in 2016, the company began operations in Texas’ Permian Basin, one of the most lucrative oilfields in the United States. This area has various low cost oil producers, so it is one of the first areas to see an uptick in activity since oil prices have begun to recover over the past year. This investment has paid off as it helped the company post a 22% revenue increase over the prior year period in Q1 2017.
Maintaining A Secure Financial Position
In order to maintain a secure financial position, Entrec has taken steps to ensure its financial stability. First, it was able to reduce its long-term debt, notes payable and lease obligations by $9.4 million in 2016. Next, the company amended its outstanding convertible debentures. Bondholders approved an extension of the maturity date from its original date in October 2017 to June 2021. They also approved an increase in the interest rate from 7.0% to 8.5%, as well as an adjustment in the conversion price from $2.60 per share to $1.00 per share. The company has also greatly reduced it capital expenditures (capex), with only $3.0 million of capex planned for 2017. Finally, Entrec is actively disposing of under-utilized equipment. Its 2017 goal is to realize $10 million (net) from the sale of this equipment.
In 2016, Entrec initiated a cost reduction plan that included the following actions: 30% reduction in salaried headcount, reductions in overtime hours for hourly employees, reduction in employee benefits, and reductions in fixed equipment costs. These actions, combined with several others resulted in an annual savings to the company of $13 million.
Q1 2017 Results – Back on Track
Entrec posted very encouraging results for its first quarter of 2017. The company’s business returned to growth with revenues of $37.3 million, up from $30.6 million in Q1 2016, representing a 22% increase. Adjusted EBITDA also increased year-over-year, coming in at $2.3 million as compared to 1.4 million in the prior year period. Adjusted EBITDA margin also increased for the three months ending March 31, 2017 – 6.1% as compared to 4.6% a year ago.
The company’s revenue growth in the first quarter was a direct result of the significant growth of Entrec’s U.S. operations. In the first half of 2016, the company expanded its operation into the Permian Basin in West Texas, one of the most lucrative oil fields in the country. As oil prices have begun to recover from their historic lows in the past few years, this area has become one of the first regions on the continent to experience heightened drilling activity. Additionally, U.S based revenue increased in the first quarter to $9.7 million, up from just $2.6 million last year.
The following graph from Entrec’s May 2017 presentation puts Q1 2017 into perspective as it relates to 2016. It appears that Entrec has a great start to 2017.
Management at Entrec acknowledges that oil prices are still subject to volatility. However, they feel the outlook for the remainder of 2017 and for 2018 is improving. John Stevens, Entrec CEO, feels that if oil prices continue to stabilize, this could lead to higher industry activity levels that should result in pricing improvements for their services (which are down 25% from peak in 2014). The company expects Maintenance, Repair and Operations (MRO) work in the Alberta Oil Sands region will continue to grow in 2017. Currently, MRO work makes up 20-25% of Entrec’s consolidated revenues. Management anticipates that portion growing in 2017 to 30-35% of consolidated revenues. The company also expects revenues from its operations in the Permian Basin to grow significantly in 2017 as well. Lastly, the HighMark acquisition in 2016 has opened up new opportunities to capture projects in the power generation sector as well as public infrastructure projects in Manitoba, Newfoundland, and Labrador.
For its most recent quarter ending March 31, 2017, Entrec Corporation had operating income of $2.65 million (without depreciation and amortization expense) and interest expense / finance costs of $2.06 million for an interest coverage of 1.3x. Although this coverage is not as high as other bond reviewed on Bond-Yields.com, it does appear that Entrec is starting to recover as evidenced by their latest quarterly results.
For bondholders, the default risk is Entrec’s ability to sustain its recent gains in revenues. The company is looking to build on its successful first quarter and maintain this momentum throughout 2017 and into 2018. It has successfully amended its outstanding convertible bonds, reduced costs and made efforts to diversify its revenues streams as well as incorporate new locations that can utilize its services. With Entrec as a market leader in a niche industry with high barriers to entry, it appears the outstanding ~12.7% yield-to-maturity on its 2021 convertible bonds outweighs the risk identified.
As much of Entrec’s revenues are still tied to the health of the oil and gas industry, which in turn is directly affected by the price of oil and gas, Entrec is exposed to revenue volatility based on the fluctuations of the price of oil. Oil prices have seen a recovery in the past year, but if prices were to fall again, this could decrease revenues for Entrec.
In general, bond prices rise when interest rates fall and vice versa. This effect tends to be more pronounced for lower couponed, longer-term debt instruments. Any fixed income security sold or redeemed prior to maturity may be subject to a gain or loss. Higher yielding bonds typically have lower credit ratings, if any, and therefore involve higher degrees of risk and may not be suitable for all investors.
Summary and Conclusion
Entrec is a key player in a specialized industry. The company has worked hard to reduce expenses and debt. It has added additional service locations like the Permian Basin, and has diversified revenue sources through its acquisition of HighMark. Entrec’s first quarter results show a company that is getting back on track after a challenging few years. The company’s convertible 2021 bonds, denominated in Canadian dollars and indicating a current yield-to-maturity of about 12.7%, offers investors diversification into the heavy haul transportation industry, and makes a fantastic addition to our FX2 managed income portfolios.
Issuer: Entrec Inc.
Price: $0.17 CAD (as of 06/16/2017)
Conversion Option Price: $1.00 CAD
Yield to Maturity: ~12.7%
To learn more about this bond, call our fixed income specialist at: (971) 327-8847
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Registered Investment Advisor
DIR (971) 732-5119
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Disclosure: Durig Capital clients may have positions in Entrec Corporation’s 2021 convertible debentures.
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To learn more about this bond call our fixed income specialist at 971-327-8847