PFIE page 2
A page 1 summary might be that the top management and board are tilted towards serial entrepreneurship and investment banking. Management background is with small and possibly unsuccessful companies. At least there is no record of success. But, what about the market opportunity and product and moat? Maybe they have it right this time.
As is well documented, there is a large (relative to current revenues) market opportunity. In North America they see 2.6 million “vessels” with either the regulatory need or the economic incentive for retrofitting with their two product lines. In good times, there are/were 45 to 50 thousand new wells coming online annually. For comparison, Profire has only 38,000 units installed now. The new wells would provide an opportunity for 95,000 to 100,000 burner management units (BMS) as each well can have multiple vessels performing different tasks or providing redundant equipment for the same process. The new acquisition of chemical metering units adds another one or two sales opportunities at each well. I believe the chemical metering is not regulatory driven, economics only.
What is unusual about the regulatory driven market, is that the regulations are being introduced only now. It would be similar to new regulations requiring seat belt use in some jurisdiction. BMS have been standard for burners everywhere except on these small, oil/gas field units for…. 60 years? The safety issue so much talked about relates to the common practice of igniting these burners with…. AN OILY RAG ATTACHED TO A STICK. The danger is that the vessel can have an explosive fuel/air mixture inside just waiting for an ignition source. When these things blow up, it is the front wall or back wall that typically give way. The burners are mounted on the front wall and that is where the operator would stand when sticking the flaming oil rag torch into the vessel.
The regulatory emphasis is more emission related than safety related though. These units are located in the middle of nowhere, operate unattended. They get checked now and then. If the flame goes out, the fuel (normally natural gas or some available gas from the well) continues to enter the vessel. Methane is 25 times more “effective” as a greenhouse gas than is CO2. So, methane escaping from hydrocarbon processing is not good, although in aggregate maybe small in comparison to farting cows and wood-chewing termite emissions. The economic side of this is that the gas being dumped out to atmosphere is gas not gathered and sold plus the well production is not treated while the burner is out of service. The safety issue and the lost production have not been large enough economic issues to justify the extra expense of adding a BMS and associated valves. Too long of a return on investment, and this is, or ought to be an indication of the price sensitivity for any kind of equipment going into an oil field.
I was always impressed when I went to natural resource extracting/processing plants: forest products, copper smelting, oil fields, sugar mills, …. Not too far below the surface of the process—sometimes right on top—was an almost stone age crudity. And a frequent theme was to not spend too much and don’t get anything fancy and no downtime. Big money was invested to find, grow, dig, extract the resource and the value of the processed item over raw material was large so no downtime. Keep it simple, rugged and reliable. With regard to a BMS, sure, I have a safety issue and sure, I vent some hydrocarbons, but if the BMS goes in I have to add ignitors, flame sensors, temperature sensors, valves, electronic controls. Any of these can fail so do I have more reliability or less? Do have more maintenance expense than lost product? That is why there is a potential market of 1.3 million wells long overdue for retrofitting. It is time for the oil fields to enter into at least the 20th century and that is good news for PFIE.
However, since BMS have been around since about the time of Moses, one shouldn’t really expect that there is any technology-driven moat here. The systems are simple. Step one, do I want the burner on? This input might come from an operator pressing “start” button (not located in front of the unit, please), or with a BMS controlled system the unit might be “on” but a temperature sensor on the process side might signal that the stuff in the tubes is too cold. Step two, does the flame sensor detect a flame? If yes, there is a problem since either there really is a flame in there when there shouldn’t be, or there is no flame and the sensor has failed. In either case you want the sequence halted. If the input is good, i.e., “no flame”, the pilot flame is ignited (valve opened, spark ignitor on). After a few seconds, if the flame detector does not sense a flame, the valve closes. There may be one or more relight attempts allowed. If a flame IS detected, the main fuel vale is opened and after some seconds elapse, the pilot valve is closed so there should be only a main flame. If it is detected, the BMS releases control of the process control system except for the flame “on” or “off” sensing. If the sensor fails to sense a flame, the fuel valves close. For “modern” systems, there are MODBUS features and the “alarm” condition can be communicated from the remote location to somewhere there are people monitoring the oil field operations. Of course there can be more than this, but those are the basics. In the dark ages, the logic was designed with switches and relays. Then programmable logic controls were used, and now specially designed printed circuit boards with some peripheral modules are packaged into small, hazardous location enclosures with various touchscreen menus and options.
Profire and the three named competitors all use the same type of system. The images shown on the companies’ web pages seem to favor the Profire BMS. Just looks better, the manuals look better. My guess is that Profire put more money into the design of the equipment and the web site than the competitors which are probably even smaller than Profire. I tend to think of moats in terms relating to advantages of technology or manufacturing. I don’t see any particular moat in those areas, although Profire might develop, or maybe has developed some advantage based on larger manufacturing volume. The competition seems to all be private companies so no reporting.
Profire has broader market reach, with presence in California, Utah, Teas, Alberta, Oklahoma, Pennsylvania and Colorado. Surefire is in New Mexico and Texas. ACL is in Alberta, Montana and Texas. Platinum is in Fort Worth.
My previous comment that the installers of Profire are also potential competitors is probably overblown, given that these BMS are more sophisticated than even the PLC based systems of yore, and whereas the BMS function COULD be provided by an oil field service company, the advantage of a standard system with proven performance ought to be easy to sell to the engineering department of an oil producer. Stick this in and meet the requirements and save some money. No design review, no as-builts. I see the marketing battle to be at that level and I see a current advantage to Profire. But the market is composed of many, many customers that are geographically dispersed so there is plenty of opportunity for the competition to win the battle at any particular company and one should make their own evaluation of what % of the market Profire can grab.
One thing to keep in mind is that the bigger market opportunity is the regulatory driven retrofit market. They mention 1% to 2% market penetration right now. The regulations are state-by-state now but the EPA rule is expected this year. How long the oil producers will have to implement, I don’t know. I’m sure they will lobby for time. I think we should expect a surge in sales for three to five years and then the market would be only/mostly for new wells and therefore more dependent on oil prices. One would think that the price of oil will be higher in 3 to five years, but who knows? This potential surge in sales plus the limited number of competitors currently would suggest good times for Profire. Their units sell for around $4,500 now and they size the market at over $11 billion. Give them $6 billion of that over 5 years, and later we’ll do the math on earnings, assign both a rational and exuberant P/E and see if it is worth some investment.
Another question is whether Profire could actually produce $1 billion a year or more over the next 5 years? I think that’s 44,000 a year average, although there would a peak year with significantly more. They have 38,000 units installed now. On the surface, it would not seem to be a problem. However, reading the latest 10-k we see two items. First, Profire hired “a dedicated purchaser”. Translation: Profire did not even have a purchasing department. Granted, they contract out the manufacturing and we don’t know those contract terms. So here is both a problem and an opportunity. As volume ramped, there could be volume cost savings for components. Also, we are informed that an accounts receivable clerk was added to that now there are both an accounts payable clerk and an accounts receivable clerk. Profire is SMALL, as I suspect Flooring Zone, Titan, and Keaton were. I see operational challenges ahead and at least no board level emphasis business operations although there is the Zink experienced director.
One final issue for somewhat of a revisit is the “bubble” nature of the market opportunity. I always preached that companies did not operate in A MARKET, but rather to a large number of individual, short term markets. At least that’s the way it was in my time and place. You may have mostly repeat customers, or sometimes an increase in new customers, but your customers—or your customers’ customers—are either individually or collectively facing a current or looming problem or opportunity. It seems that in all cases, the cycle is awareness, solution, first sales, acceptance and volume sales, entrance of competition, customer problem solved or opportunity served. “All” markets have five year cycles. That’s rule 1. If this market is “different”, go back to rule 1. In this case, there may not be the stage of entrance of competition as there are already three competitors with established products. The market is large in relation to existing sales, but not so large as to draw in a new competitor—I think. It is possible if the implementation of the new rules are drawn out over many years, a new competitor might enter the fray. Of course there are currently a lot of oil field equipment suppliers with excess capacity and a hunger for filling revenue shortages so it would not be a shock that within a year they could have a nicely packaged unit and a sales presence with existing products at the oil producing companies. It all depends on the relative size of the companies and the market size and the need/motivation for revenue.
If Profire gets a large market share, can they digest it? How do they digest it, with internal staffing or outsourcing? Are they left bloated in years 4 and 5? Do they sell out to a larger company in the exuberance of year 3? My ideal investment thesis would be the latter given the makeup of the board and the history of the founders. I wouldn’t buy PFIE with expectation of its having a hold forever, 10-20 year horizon. Any purchase would be a speculation that there will be a ramp up of revenue and a good sales job to Wall Street or investment banks and maybe a buyout.
I think there will be a page 3 to project some sort of possible earnings statement for year three. We’ll see. Don’t throw away PFIE speculation idea just yet.
PFIE page 2
Before I get too badly flamed by responses, I should note that the regulations and proposed regulations do not mandate BMS on these devices. Some mandate “auto ignitors”, some mandate control of emissions and some mandate conditioning of the crude prior to transportation. Emission control can be by flaring or vapor recovery, for example. The BMS can “help manage” the mandated controls or equipment, according to Profire. That is why Profire has stressed that they have attractive growth opportunities even in the absence of regulation because the ROI on the installed Profire equipment. History says that most producers will do the minimum cost-wise to meet the regulation. There are always exceptions just as there already are with this equipment. But we needn’t stress over the need to ramp production by 100 x’s in the near future due to regulatory pressure.
Another item lost in info mountain: last week Mr. Albert Limpert resigned as CFO effective June 15, after the 10k and earnings call are completed. He was at Profire since 2007 and was instrumental in getting PFIE listed on a national exchange. One would not think that he would walk away from a multi-bagger growth company with buyout opportunity possibly looming.