From Dain Rauscher just minutes ago:
KEG:SB-Spec;ANY RECENT WEAKNESS IN KEG HAS NO BASIS IN FUNDAMENTALS, BUY THE STOCK
Key's stock price is down approximately 20% from its highs of this year while the OSX is off only about 12% which, considering KEG's valuation relative to its peer group, the momentum behind its improvement and the outlook for the company, does not appear sustainable. The stock has been under some pressure for the past few days and indications are that a fund is being hit by redemptions and is liquidating positions that include Key Energy. Since we can find no fundamental reason for the weakness at all, this explanation appears most plausible. || ||After going over operating and financial results with the company extensively lately, we find that operations are improving more rapidly than expected, margins are moving up stronger and faster than expected and the outlook, due to a number of factors, continues to improve at an accelerating rate.
Rig utilization is up approximately 50% over last year, to 75%, and the sequential improvement continues. Workover rig hours are up almost 50% as well. We are expecting EPS of ($0.04) for the quarter versus a consensus of ($0.05) and we fully expect to be correct. We also expect it to be the last losing quarter since the company was profitable for the month of March.
As we noted in a comment last week, for the quarter, Key will have reduced (or taken irrevocable action to reduce) its long-term debt by a total of approximately $31 million in the quarter. It has completed the swap of some noncore business units (production and well test) in South Texas for assets (trucks for workover support and disposal) where Key has critical mass in the same area and should be able to significantly boost margins. It has sold approximately one-tenth of its total proved oil and gas reserves for $20 million. These are positive moves by the company--especially the debt reduction--and so early in the cycle. Also, the production payment monetizes the Odessa oil and gas subsidiary much more effectively than a sale.
Oil and gas prices remain easily strong enough for the growth and improvement in fundamentals to continue. We would take advantage of a near- term inefficiency in the market and aggressively buy the stock.
Stock Opinion
Our near-term price target on KEG is $14 per share based on the strong cash flow generation capability of the company and the ability and willingness to de-leverage the balance sheet from operating cash flows. At 10x our 2001 cash flow estimate of $1.40 per share, still a discount to the peer group valuation, we expect the stock to continue its recent momentum and trade up further as pricing, utilization, and results improve. || ||KEG currently has an existing asset base that can generate at least $250 million in EBITDA without any further acquisitions, but well before any concerns about replacement-level day rates. Our current forecast for FY2001 is only $159 million. At the current Enterprise Value/EBITDA multiple, the EBITDA target would imply a stock price of $17.50. Assuming that level of cash flow would be reached in two years, discounted back, we get a price target of $14 per share. Clearly, reaching that level earlier pushes our price target higher.
Since the company continues to reduce debt, lowering its risk profile, we should see multiple expansion. The higher operating margins and accelerating growth argue for multiple expansion as well.
Company Description
Key Energy is the world's largest rig-based well servicing firm, owning approximately 1,400 well service rigs and 1,200 oilfield trucks, as well as 73 drilling rigs. The company provides diversified energy operations including well servicing, contract drilling, and other oilfield services and oil and natural gas production. The company has operations in all major onshore oil and gas producing regions of the continental United States and in Argentina and Ontario, Canada. |
