Upgraded capex guidance at Natural Gas Services

Management guides to 20%+ ROIC

Dear Reader,

I’ve just drilled into some details on NGS 0.00%↑ 2024Q2 and I like what I see. At first I was disappointed by lack of sequential EBITDA growth, which isn’t a huge surprise given the lumpy nature of their deliveries, but I figured would have attracted more attention from the market. But after hearing out management’s capex plan and running some numbers, I am pretty satisfied and plan to hold my position for a better price.

ROIC distinction is adding upside

The new CEO has specifically identified a target of 20% on ROIC. I don’t recall past management ever getting quite this specific / technical account-wise when discussing potential investments. Vaguer descriptions such as “15%-20%” “cash on cash returns” led me to more conservative modeling of free cash flow in particular by assuming a 15% to 20% EBITDA margin on capex. But ROIC is NOPAT/CAPEX — NOPAT gives us another 5% from depreciation added back to cash flow while EBITDA would need both depreciation and tax added back.

So when the new CEO says current investments are exceeding the 20% ROI target, I think he’s talking about adding 25% of capex - interest to cash flow.

Validating the ROIC narrative

I’m gonna’ keep these numbers simple because we don’t know how much recent capex is still pre-revenue. What I see is roughly $200mm capex since 2022 and $30m-$40mm in associated NOPAT. That puts recent investment at 15%-20% ROIC, in line with previous management’s guidance. New management has raised effectively the bar to 20% while also calling out that recent investments are above that bar.

Updated valuation

We’re going to end the year at approximately $70mm EBITDA run-rate. We have $150mm net debt. Management has indicated plans to spend approximately $150mm growth capex through 2025, which would increase EBITDA by $37.5mm (possibly more, due to the taxes).

Assuming $105mm EBITDA run-rate and $250mm net debt at 2025 EOY, a 6x multiple would get the share price to ~$30 and an 8x multiple would get us to $47.50.

I think management would at this point be interested in a takeout at over 8x EBITDA but could be tempted to press into strong demand for 2026 orders.