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Drilling Into Cathedral Energy Services' Present And Future

Nathan Kirykos
November 4, 2013

One company that has been capitalizing on the shale revolution in North America is Cathedral Energy Services (TSX: CET). Cathedral provides directional drilling and production testing services to the energy players that exploit the horizontal drilling and hydraulic fracturing to target previously untapped shale fields.  

Being proactive, not reactive 
In the first half of 2013, Cathedral's EBITDA, cash flow, and net income plummeted as compared to 2012. This decline was primarily attributed to a slow down of drilling and completions work in the Canadian market, where Cathedral is heavily exposed.

The oil price differential in Canada narrowed in 2013, leading to more dollars in the hands of producers. This hasn't yet resulted in increased funding for drilling and completions programs, however. So far in 2013, industry activity levels in Canada are at lower levels than the prior year and rig counts continue to lag those of last year as well.

From a debt perspective, Cathedral's debt-to-EBITDA ratio is in safe territory. As of June 2013, the company's net debt is $28 million and its estimated EBITDA for 2013 stands at approximately $29 million. However, Cathedral might need to trim its dividend which requires approximately $11 million annually, while the operating cash flow and CapEx for 2013 are about $26 million and $27 million respectively. 

To avoid a dividend cut and prevent the pressures in the Canadian market from hurting its balance sheet further, the company is diversifying its operations geographically with the goal of enhancing profitability. First, it is ramping up its efforts in the U.S., targeting both directional drilling and frac flowback services in Texas and Oklahoma. Secondly, Cathedral plans to capitalize on Venezuelan opportunities through a joint venture with Petroleros de Venezuela, the state-owned oil and gas corporation. 

Why Texas and Oklahoma?
Since early 2013, Cathedral has been increasing its investment in the U.S. by way of infrastructure and capital equipment. It has primarily targeted expansions in Texas and Oklahoma, which together make up the biggest energy market in the U.S. today.

Cathedral's U.S. Directional Drilling division opened recently with operations base in Oklahoma. Commencing in January 2013, the company's U.S. Production Testing division also expanded its operations into the Eagle Ford resource play in Texas.  

As a result, Cathedral's U.S. revenue rose 10% for the first half of 2013 on a year-over-year basis, and the U.S. operations generated 60% of the total revenue. More importantly, Cathedral expects the upward trend to continue for the remainder of the year, as both the Texas and Oklahoma regions are seeing increased activity levels.

While Cathedral is moving aggressively to take a piece of the pie in these two regions, C&J Energy Services (NYSE: CJES) has already built up a dominant position there. C&J is also a provider of hydraulic fracturing, coiled tubing, pressure pumping, and wireline services with a strategic presence both in the Permian Basin and the Eagle Ford play. Thanks to the resources in Texas and Oklahoma, C&J's performance has been exceptionally strong since 2010. The company has produced a triple-digit compound annual growth rate (CAGR) for its revenue, EBITDA, and operating cash flow during the last two years. Moving forward, C&J plans to expand into new emerging plays like the Niobrara and the Utica formations as well.

Why Venezuela?
Cathedral owns 40% of Vencana Servicios Petroleros, which operates in Venezuela where the world's largest oil reserves are found. The state-owned oil company's production and earnings all appear to be on a downward slide, however.

After 10 years of dramatically bad underinvestment, Venezuela hasn't invested its profits in infrastructure; as a result, the infrastructure is currently worn out. The government has taken so much money out of the oil industry to use for social spending, military spending, and government overhead that the sustaining capital is not there. When Chavez died, he left the state-run oil company in such dire straits that many say $100-a-barrel oil may no longer be enough to keep the country afloat barring a complete overhaul of a deteriorating petroleum industry.

The new leadership in Venezuela seems to have realized this problem. The country is trying to address the problems of declining production and infrastructure deficiencies by redeploying foreign capital inside the country. Venezuela's daily crude production was 2.5 million barrels a day in 2012, and the country projects production to reach 4 million barrels a day in 2014 and to 6 million by 2019.

If capital and rigs are applied, Venezuela's assets are capable of generating multi-year, double-digit increases in oil production. This has been demonstrated by Petrodelta, which is partly owned by Harvest Natural Resources (