Water Infrastructure Growth Powers Sustainable Earnings And Margin Expansion

Key Takeaways

• Aggressive expansion into water infrastructure aims at boosting revenue and gross profit through acquisitions and high-margin projects like increased recycling capacity.
  
• Strategic focus on operational efficiency and long-term contracts promotes predictable, sustainable revenue streams and could significantly enhance margins and EBITDA performance.
  
• Exposure to seasonal, permitting, contract, commodity price volatility, and acquisition integration risks could significantly impact revenue, margins, and profitability.

Catalysts

Provides water management and chemical solutions to the energy industry in the United States.

• The aggressive expansion into water infrastructure, including accretive acquisitions and organic growth projects, directly targets boosting revenue and gross profit in this high-margin segment. For instance, the construction of up to 360,000 barrels per day of incremental water recycling capacity and 4 million barrels of storage in the Northern Delaware system.
  
• Strategic acquisitions in both the water infrastructure and disposal assets domains offer an immediate increase in permitted disposal capacity and are indicative of a strategy to improve margins and secure long-term contracted revenue, which supports sustainability and predictability in earnings growth.
  
• The ongoing effort to reduce maintenance capital and enhance operational efficiency across all segments potentially leads to increased net margins by lowering operating costs and improving asset utilization rates.
  
• Initiatives to secure long-term contracts and acreage dedications support predictable revenue streams and could enhance the company's ability to plan and invest with greater certainty in profitable ventures, directly impacting revenue growth and stability.
  
• The focus on enhancing water recycling and disposal facilities utilization, coupled with the expected upturn in demand for high-quality water management solutions from large operators, could significantly drive both top-line growth and margin expansion, showcasing a potential improvement in earnings before interest, taxes, depreciation, and amortization (EBITDA) performance in an industry trending towards more sustainable water usage practices.

Assumptions

• Analysts are assuming Select Water Solutions's revenue will grow by 5.0% annually over the next 3 years.
• Analysts assume that profit margins will increase from 3.9% today to 8.0% in 3 years time.
• Analysts expect earnings to reach $138.0 million (and earnings per share of $1.32) by about September 2027, up from $58.4 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 14.7x on those 2027 earnings, down from 19.0x today. This future PE is lower than the current PE for the US Energy Services industry at 18.0x.
• Analysts expect the number of shares outstanding to decline by 0.82% per year for the next 3 years.
• To value all of this in today's dollars, we will use a discount rate of 7.86%, as per the Simply Wall St company report.

Risks

• The seasonal impacts mentioned could affect the margins negatively, particularly in the fourth quarter, potentially impacting net margins and overall profitability.
  
• Permitting delays, such as those experienced with the Thompson pipeline, could lead to project delays, impacting revenue growth projections and the timing of cash flow improvements.
  
• Dependency on long-term contracts and project execution has inherent risks. If Select Water Solutions fails to secure additional long-term contracts or face execution challenges, this could limit revenue growth and margin improvement in the Water Infrastructure segment, affecting earnings.
  
• The mention of reduced activity in the chemical technology segment and pressure from natural gas price fluctuations suggests that the company's performance is susceptible to commodity price volatility, which could impact revenue and earnings in these segments.
  
• The significant amount of acquisitions may pose integration risks and challenges in achieving expected synergies, potentially impacting the company's ability to improve its gross margin as planned and affecting earnings.

Valuation

• The analysts have a consensus price target of $13.9 for Select Water Solutions based on their expectations of its future earnings growth, profit margins and other risk factors.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $1.7 billion, earnings will come to $138.0 million, and it would be trading on a PE ratio of 14.7x, assuming you use a discount rate of 7.9%.
• Given the current share price of $10.82, the analyst's price target of $13.9 is 22.2% higher.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.