Strategy Evaluation
Our short article discussed our initial thoughts about ProFrac Holding’s (ACDC) Q3 2023 performance a couple of weeks ago. This article will dive deeper into the industry and its current outlook. During the recent drilling and completion activity downturn, the company was affected more than some of its peers due to its flexible strategy (i.e., prioritizing returns over market share gains).
So, it has shifted to a more multipronged strategy that required its business model to adopt a “cyclic resiliency” approach. In Q3, ACDC reduced the number of active frac spreads. It expects frac utilization to be lower in the industry such that the pressure pumpers can prudently deploy horsepower. As the supply side right sizes, the company’s management believes that it can reactivate some idled fleets in 2024.
Frac Spread And Outlook
In Q3, ACDC reduced its fleet count to accommodate full utilization. Due to improved efficiencies, the adverse effect of seasonality will be less in Q4. It is also focused on receiving dedicated agreements with operators. The company expects to see stable pricing for its fracking services in Q4 compared to Q3.
In Q1 2024, it plans to operate 30 frac spreads and may continue to add to the number later in the year. While its dedicated fleets accounted for ~30% to 40% in 2023, the share of dedicated frac spreads will likely increase in 2024. Over the medium term, it targets ~75% of its frac fleet working on a dedicated basis. For further discussion on ACDC’s Q3 performance, please read our article.
Analyzing Segment Drivers
In October 2023, ACDC started evaluating the Proppant Production segment’s strategic options, including its subsidiary, Alpine Silica. Through higher throughput in sand mines, it expects a higher volume of contracts within 2024. Approximately 52% of its capacity is committed to third-party customers. Because of improved profitability, a more stable earnings profile, and higher cash conversion, it sees strong potential at Alpine. So, ProFrac explores and pursues asset-level financing for the Proppant segment. A different lender base would simplify its capital structure and extend the current maturities. It can also dig into the current capital base through an IPO of the segment. So, its strategic options will vary between divesting the segment and recapitalizing the business.
Over the past year and a half, ACDC has vertically integrated its pressure pumping services. It has electric, dual fuel, and traditional diesel frac equipment, complemented by its proppant services. It plans to position Alpine Silica as an independent entity, which reflects its current strategic evaluation exercise. If it goes through, the company can realize a higher price because it will sell sand at a higher price to a third party. Also, it would allow ACDC to buy sand at a lower price. This will strengthen the competitiveness of the Stimulation Services Segment because third-party proppant customers and competitors will enable Alpine to maximize utilization and reduce its cost per ton.
Cash Flows And Debt
ACDC’s cash flow from operations doubled in 9M 2023 compared to a year ago. Although capex increased, its FCF also made a massive gain. The cash flow improvement reflects higher revenues and better working capital management. In FY2023, the company plans to incur $285 million in capex, which would be 20% lower than a year ago. On maintenance, it plans to spend approximately $3.5 million per fleet per year for the Stimulation Services segment and $2 million-$3 million per mine per year for the Proppant Production segment.
In Q3 2023, the company repaid $112 million of its debt. It expects the leverage ratio to fall below its target of 1x adjusted EBITDA in 2024. ACDC’s leverage (debt-to-equity) was 0.79x as of September 30, 2023. It had $36 million of liquidity as of that date.
Relative Valuation
ACDC is currently trading at an EV/EBITDA multiple of 3.2x. Based on sell-side analysts’ EBITDA estimates, the forward EV/EBITDA multiple is 3.5x.
ACDC’s forward EV/EBITDA multiple expansion versus the current EV/EBITDA is steeper than its peers because its EBITDA is expected to decrease more steeply than its peers in the next year. This typically results in a lower EV/EBITDA multiple than its peers. The stock’s EV/EBITDA multiple is lower than its peers’ (LBRT, PUMP, and HAL) average. So, the stock is reasonably valued versus its peers.
Final Commentary
ACDC idled one frac spread in Q3. As the frac price stabilizes, the company’s management believes it can reactivate some idled fleets in 2024. Given the trend, the share of dedicated frac spreads will increase in 2024. In October 2023, it started evaluating the strategic options for its subsidiary, Alpine Silica. It explores asset-level financing for the Proppant segment to simplify its capital structure. Positioning Alpine Silica as an independent entity will unlock value by selling sand at a higher price to a third party. The strategic alternative will also allow it to maximize utilization and reduce its cost per ton.
ACDC was affected more than some of its peers in the recent drilling and completion activity downturn following its strategy to prioritize returns over market share gains. With higher cash flows, it expects the leverage ratio to fall below its target in 2024. Its free cash flows increased significantly in 9M 2023, with further improvements in cash flows expected in 2024. The stock is reasonably valued versus its peers.
