Xtreme Coil Drilling: Undervalued Drilling Company on the Cusp of Strong Growth

Xtreme Coil Drilling markets high spec drilling rigs and coil service rigs ideally suited for unconventional resource plays. With the advent of the shale revolution not only is the number of horizontal wells steadily rising, companies are drilling deeper wells with longer lateral legs which is exactly where XDC’s specialty comes in. XDC is currently trading at about 0.6x of Book Value which makes it one of the most undervalued stocks in the energy services sector. But wait, there’s more, analysts are forecasting a 70% increase in rig operating days in 2012 fueled by a 50% increase in its average fleet size.

Xtreme XDC.TO 2.28 [-0.02] was once a $10 stock (back in 2008) but it has not been getting a lot of love lately as it carries some baggage. The history starts with Xtreme’s sudden loss of its drilling contract with a global integrated oilfield services company in Mexico back in 2010. The company has to be commended for redeploying its rigs back in the USA on the double even if the rates were not enviable at the time. More recently, management was shaken as the CEO left and was replaced with one of the founders, Richard Havinga, a capable fellow as well. This shake up along with a long set of delays in the delivery of new drilling and coil service rigs undermined the stock chart. However, I believe the company is on the cusp of strong growth as one new rig after another enters the field through H1 of 2012.

Xtreme’s rig fleet is less than 3.5 years old which makes it one of the youngest fleets. The company’s operations are largely based in the US but currently reach into Canada with 3 drilling rigs and the Middle East with 2 coil service rigs operating in Saudi Arabia. Xtreme’s XSR units (Coil service rigs) are used for frac clean-outs after a well has been drilled and fracked. The smaller diameter coil is also suitable for a multitude of complex services such as wellbore extensions and production logging. The XSR machine is retrofitted for deep coil service work which is suitable for plays such as the Bakken and the Eagle Ford. Herein lays the advantage of Xtreme’s XSR units as they can clean out wells from 20,000-23,500 feet in length versus the competition’s smaller coil units which can only work in depths up to 18,000 feet. The company anticipates deploying 4 new XSR units in Q1 and early Q2 of 2012, these units have a much higher profit margin than drilling rigs. The daily rate for an XSR unit is about $40k/d with a cost to build of $7M while for an XDR unit it is $25-$30k/s at a build cost of $17M. By the end of Q2, Xtreme should have 5 XSR units working in the Eagle Ford play down in Texas where rates are strong, demand is high and where there are no weather issues!


Ultra Deep Coil Service Rig

On the drilling side, the company’s XDR 500 series can be found punching holes in 3 liquids rich/oil resource plays: Eagle Ford in Texas, DJ Basin/Niobrara in Colorado and the Bakken in North Dakota. By the end of the build program, Xtreme should exit 2012 with 21 rigs versus 15 at the beginning of the year.?? The last update mentioned a fleet of 16 XDR drilling rigs which leaves 5 new builds coming out and the best part of it all is that they are all contracted for 3 years except for 1 which has a 2 year contract. What does that mean? It means that for 2012 70% of the cash flow is locked!

Building those new rigs has been part of the reason the stock price languished, the company did all the heavy lifting in terms of spending in 2011 which should be winding down in the first half of 2012. However, for the second half of 2012, it will be time to reap the profits which will bring current debt levels lower(currently $125M used out of a $150M credit facility). XDC is not expected to suffer in a prolonged period of natural gas weakness as its operations are leveraged to oil and liquids plays.


The market will pay for growth sooner or later!

I love investing in a company enjoying rising cash flow, but what I love more is a company that comes with free wild cards and XDC has 2 of those. The first one is a new mining rig it is currently testing with a JV partner (a mining company footing 100% of the bill in exchange of operational/engineering knowledge). This new rig is supposed to drill down up to 10x faster than a traditional mining rig. A commercial decision on this prototype is due in 2012. The second freebie is a legal outcome to the unilateral termination of drilling contracts by the global integrated services company down in Mexico (why let them get away with that right?). In March, a trial will decide if the jurisdiction of the case will be in Texas or in Mexico. The company strongly believes that if the jurisdiction is set in Texas, the defendant will want to sit down and settle (do I hear the sound of clinking coins?)

Finally, if its not Q1 financial results it will be the Q2 results that will announce the inflection point for Xtreme but I won’t be waiting for the market to wake up on its potential as I already established a position in the stock. The upside is at least 50% if the company is to trade at book value but I believe the upside is bigger than that once the market values this company according to the sector valuation which in my opinion is only a matter of time.

Disclaimer: I have a position in Xtreme Coil Drilling. This??article is not and should not be construed as an offer to sell or the solicitation of an offer to purchase or subscribe for any investment, please do your own due diligence before taking an investment decision.??