Pull 11.4% YTM with Entrec Corporation Fixed Income Bond Review, Maturing June of 2021

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Entrec Corporation, 11.4% Yield-to-Maturity, Matures June 2021

(all figures quoted are in CAD dollars)

Durig Fixed Income 2 (FX2) takes our second look at a Canadian heavy haul transportation and crane company providing service to natural resource companies, as well as the construction and power generation industries, among others. In our last review in June 2017, the company was beginning to see the fruits of its efforts to diversify its revenue sources as well as reduce its ongoing operating costs. Now in its most recent quarterly and year-to-date (YTD) results we see these trends continuing.

Adjusted EBITDA was up 286% for Q2 and up 9.5% for Q3 compared to same periods in 2016.
Q3 revenues of $36.7 Million showed a 29% increase year-over-year, reflecting revenue growth from its operations in the United States.
Expenses continue to decline with General and Administrative costs down over 12% YTD as of Sept. 30, 2017.

Entrec remains cautiously optimistic about the increase in oil and gas activity in its operating areas in Texas and North Dakota. The company is also planning on expanding operations into Wyoming and Colorado this year, and is also seeing increases in revenues from its infrastructure projects. US revenue increased to $14.2 million in Q3 from just $4.3 million last year, and the company expects revenues from its US operations to continue to grow into 2018. Of particular interest to bondholders, the company recently gave notice that it will buy back approximately $3.5 million of its 2021 bonds. Also, the company recently announced a five year extension of its asset-based senior credit facility (the ABL Facility.) Entrec’s 2021 convertible debentures have a very competitive coupon of 8.50%, and priced around 91.6 indicate a yield-to-maturity that’s about 11.4%. Adding this debt instrument from the heavy haul sector can provide added diversification (which tends to reduce overall portfolio risk), and possibly help increase both cash flow and total returns for fixed income portfolios. In light of these factors, we are targeting these Entrec 2021 notes for additional weighting in our Fixed Income 2 (FX2) managed income portfolio, the third quarter end 2017 aggregate performance of which is shown below.

Bond Buyback and Senior Credit Facility Extension

In October, Entrec gave notice that it would redeem approximately $3.5 million (about 13.8%) of the $25.3 million outstanding of its June 2021 debentures at a premium (a payment of $1,003.49 for each $1,000 principal). This action should boost bondholder’s confidence in the company’s ability to redeem a significant portion (if not all) of these notes prior to the March 31, 2021 resolution date set by ABL Facility. The five year extension of the ABL Facility, which now matures in October 2022, was good news for bondholders, giving Entrec the much needed flexibility within its credit facility to pay off these 2021 bonds.

Impressive Third Quarter and Year-to-Date Results

In its most recent quarterly results, Entrec posted solid gains in many of its key financial measurements. Here are some highlights:

Revenue for the three months ending September 30, 2017 was $36.665 million as compared to $28.394 million in Q3 2016, an increase of 29.1%. This increase was primarily due to growth in the company’s U.S. operations.
Adjusted EBITDA was $2.8 million for the quarter, up from $2.55 million in 2016.
Entrec’s U.S. revenues increased to $14.18 million in Q3 from just $4.285 million last year. This increase reflects the company’s expansion into the Permian Basin in Texas as wells as increased activity levels in North Dakota.
Gross profit for Q3 increased to $6.373 million from $5.594 million in Q3 2016. Gross margin as a percentage of revenues decreased slightly year-over-year from 19.7% in Q3 2016 to 17.4% in 2017.

Entrec’s year-to-date (for the nine months ending June 30, 2017) numbers look equally impressive:

Year-to-date revenue increased by over 30% to $109.888 million from $84.043 million in 2016.
Adjusted EBITDA increased by over 66% for the nine months ended Sept. 30, 2017, growing to $7.767 million from $4.677 million in 2016.
Gross profit for the nine months ended Sept. 30, 2017 increased to $18.027 million from $15.082 million in 2016.

Both the U.S and Canadian economies have been experiencing recent periods of growth. For a company such as Entrec, this translates to more available work / projects requiring its heavy haul and crane services.

About the Issuer

Based in Alberta, Canada, Entrec Corporation is a heavy haul transportation and crane solution provider to the natural resources, construction, petrochemical, and power generation industries. Operating from 12 locations throughout western Canada, North Dakota and Texas, the company currently employs approximately 550 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 mutli-national energy companies such as Chevron, Conoco Phillips and Husky Energy. Entrec is one of the market leaders in a niche industry with high barriers to entry.

Source: Entrec Presentation, May 2017)

General & Administrative Cost Reductions Continue

As discussed in our last review of Entrec, the company has taken aggressive steps to cut costs, which included a 30% reduction in salaried headcount. The latest quarterly results continue to illustrate the company’s commitment to keeping costs low. General and Administrative costs (G&A) as a percentage of revenue were down year-over-year for both the three and nine month periods ending Sept. 30, 2017. G&A expenses were $3.74 million, or 10.2% of revenues, for the quarter, compared to $3.15 million, or 11.1% of revenues, a year ago. Similarly, for the nine months ended Sept. 30, 2017, G&A expenses were $10.535 million, or 9.6% of revenues, down from $11.535 million, or 13.7% of revenues from a year ago.

Looking Ahead

Entrec management expects continued improvements in revenues going into 2018, stemming largely from the expected growth from its operations in the United States. Entrec also plans to expand its operations into Wyoming and Colorado, and will also begin its first industrial construction project on the Gulf Coast. In addition, the company’s revenues from infrastructure and power projects continues to increase. Overall, management expects revenue in fiscal 2017 will be higher than 2016 and revenue in 2018 will exceed revenues in 2017. Another vote of confidence in the company’s health going forward might be the insider acquisitions of over 3.5 million shares of Entrec stock in the public market (at $0.15/share) during the month of June of 2017.

Interest Coverage

For the nine months ending Sept. 30, 2017, Entrec had operating income (without the effect of non-cash depreciation) of $7.767 million and interest expense of $5.479 million for interest coverage of about 1.4x. With the recent stabilization of oil prices and the pickup in activity in both the North Dakota and Texas regions, we think Entrec’s interest coverage ratio should continue to improve in the last quarter of 2017 and into 2018.

Risks

For Entrec bondholders, the risk lies in whether the company can continue the growth trajectory begun in the last few quarters. With energy prices beginning to stabilize (and slowly increase), the company has seen its revenues rise due to increasing activity in some of its key areas of operations, including Texas and North Dakota. Entrec has plans to expand its U.S. operations into Wyoming and Colorado into 2018. It is also optimistic about revenue growth from its infrastructure and power projects within its recent expansion into Manitoba and Newfoundland & Labrador. Considering these factors, the 11.4% yield to maturity on the company’s 2021 convertible bonds appears to outweigh the risks that we can identify.

Although Entrec is expanding into new areas, such as Wyoming and Colorado, with its services, in the short-term, this will likely increase expense and put pressure on profits. Increasing revenues from these new operations will take time and will be overshadowed by the expense side of adding operations.

As much of Entrec’s revenues are still tied to the health of the energy industry, which in turn is directly affected by the price of oil and gas, Entrec is exposed to revenue volatility based on the volatility 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 niche player in a very specialized industry. Heavy equipment is vital and necessary to support other industries such as energy and infrastructure. The recent uptick in activity in the oil and gas sector, along with the addition of infrastructure projects has meant a healthy increase in revenues for Entrec. Increasing revenues, along with the company’s cost reductions has positioned the company for an even better end to 2017 and more profitable 2018. The company’s convertible 2021 debentures, couponed at 8.5% and priced for a yield-to-maturity that’s over 11%, offer investors good cash flow and diversification into the heavy haul transportation industry. Therefore, we are marking these bonds for overweighting in our FX2 managed fixed income portfolios, the third quarter end 2017 benchmarked, aggregate performance of which is shown above.

Issuer: Entrec Inc.

Ticker: ENT (TSX)

Price: $0.23 CAD (as of 11/14/2017)

Conversion Option Price: $1.00 CAD

Coupon: 8.50%

Maturity: 06/30/2021

Ratings: NA

Pays: Monthly

Price: 91.6

Yield to Maturity: ~11.4%

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Disclosure: Durig clients may have positions in Entrec Corporation’s 2021 convertible debentures.

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