Enerflex Ltd. (EFXT) Q3 2024 Earnings Report, Transcript and Summary

Good day and thank you for standing by. Welcome to the Enerflex Third Quarter 2024 Earnings Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. [Operator Instructions] I'd now like to hand the conference over to your speaker today, Jeff Fetterly, Vice President of Corporate Development and Investor Relations.

Thank you, Josh, and good morning, everyone. Welcome to our third quarter of 2024 results call. With me today are Marc Rossiter, President and CEO; and Preet Dhindsa, SVP and CFO. During today's call, our prepared remarks will focus on three key areas. First, the strong operational performance of the business during Q3 and our outlook heading into 2025. Second, capital allocation, including direct shareholder returns and capital spending. And third, our progress on near and long-term strategic priorities. Before I turn it over to Mark, I'll remind everyone that today's discussion will include non-IFRS and other financial measures, as well as forward-looking statements regarding Enerflex's expectations for future performance and business prospects. Forward-looking information involves risks and uncertainties, and the stated expectations could differ materially from actual results or performance. For more information, refer to the advisory statements within our news release, MD&A, and other regulatory filings, all available on our website and under the SEDAR+ and EDGAR profiles. As part of our prepared remarks, we will be referring to slides in our updated investor presentation, which is available as part of the conference call link and on our website under the Investor Relations section. I'll now turn it over to Marc.

Thanks, Jeff, and thank you all for joining us on this morning's call. We are pleased to report another quarter of strong operational performance, with third quarter results reflecting solid execution across the company's business lines, as well as our hard work over the last few years building a strong, resilient company positioned for sustainable growth and value creation. The energy infrastructure and aftermarket services business lines continue to deliver steady performance, generating 65% of our gross margin before depreciation and amortization during the quarter. Slide 11 in our updated investor presentation highlights how Enerflex's business has shifted over the past 5 years and the increased stability we expect this will provide in our results over the coming years. Thus far in 2024, we have successfully reduced leverage to within our target range of 1.5x to 2.0x. We've been disciplined with growth capital and continued to reduce the cost for debt. Visibility across the company's business lines remains solid, including approximately $1.6 billion of contracted revenue supporting our EI assets and a $1.3 billion engineered systems backlog. As a result, Enerflex is able to increase direct shareholder returns with the Board approving a 50% increase to our quarterly dividend. I will now briefly touch on a few highlights for each of our business lines. Energy infrastructure continues to perform well across our three regions, the U.S., Latin America, and the Middle East. In the U.S., our contract compression fleet continues to benefit from the increasing natural gas production in the Permian Basin, operating at 94% utilization during the quarter across 428,000 horsepower. The business generated revenue of $37 million and gross margin before depreciation and amortization of 70% during Q3 2024 compared to $33 million and 67% in the prior year. Slides 18 and 19 highlight our fleet composition and the strong relative operating performance of this business. Demand for new contract compression equipment in the United States remains strong and we are selectively expanding our fleet. New units are being deployed under multiyear contracts in core operating regions with the focus on large horsepower, natural gas, and electric drive applications. Slide 16 and 17 of the investor presentation highlight our international energy infrastructure business, which includes approximately 1.5 million horsepower of operated compression and 26 build, own, operate and maintain or BOOM projects in the Middle East and Latin America. Our two produced water projects in Oman continue to perform very well, and we are in the process of expanding one of those sites. Our international energy infrastructure business is supported by approximately $1.5 billion of contracted revenue and an average contract term that exceeds 5 years. Turning to aftermarket services. This business line benefited from strong activity levels and customer maintenance activities during the quarter. We expect these trends to continue into 2025. On the engineered systems side, we recorded bookings of $349 million in the quarter and maintained our backlog at $1.3 billion. The majority of this backlog is scheduled to be converted into revenue over the next 12 months. Facility throughput remains steady and margins for this business line have benefited from favorable product mix and strong project execution. Demand for new engineered systems equipment and services in North America has been impacted by an extended weakness in domestic natural gas prices. This, combined with the anticipated overall mix of projects in Enerflex's engineered systems backlog, is expected to result in gross margin before depreciation and amortization, more consistent with the long-term average for this business line. Notwithstanding, the near-term revenue for this business line is expected to remain steady, and the medium-term outlook for engineered systems products and services continues to be attractive, driven by increases in natural gas, oil and produced water volumes across Enerflex's global footprint and decarbonization activities. Before I turn the call over to Preet, I want to emphasize that the underlying macro drivers for our business are very strong, with the ongoing focus on global energy security and the growing need for low emissions natural gas, resulting in a strong demand for Enerflex's energy infrastructure and energy transition solutions. Against this backdrop, our business lines continue to deliver solid performance, and we are focused on enhancing the profitability of our core operations, and Enerflex's ability to focus on growth and return of capital to shareholders. With that, I'll turn it over to Preet to speak to the financial highlights of the quarter.

Thanks, Marc, and good morning, everyone. During the third quarter, we reported consolidated revenue of $601 million compared to $580 million in Q3 '23 and $614 million in Q2 '24, as you benefit from additional project volumes in our engineered systems business line. Gross margin before depreciation and amortization was $176 million or 29% of revenue compared to $150 million or 26% of revenue in Q3 '23 and $173 million or 28% of revenue during Q2 '24. Adjusted EBITDA was $120 million compared to $90 million in Q3 '23 and $122 million during Q2 2024. Energy infrastructure gross margin before D&A of $91 million compared to $77 million in Q3 '23 and the same in Q2 '24 as we benefited from higher utilization and price increases on renewed contracts. Aftermarket services gross margin before D&A was 19% in the quarter, benefiting from strong customer maintenance programs. It reflects the SG&A of $82 million with $7 million higher year-over-year and on a sequential basis, mainly due to increased share-based compensation. Foreign exchange losses and loss from associated instruments remain modest during Q3 '24, reflective of global cash management strategies and lower cash balances in Argentina. Cash provided by operating activities was $98 million in Q3 '24, which included a working capital recovery of $35 million. We are pleased with our ongoing global efforts to efficiently manage working capital. Free cash flow was $78 million compared to $29 million during Q3 '23, and the use of cash of $6 billion in Q2 '24. We invested $33 million in the business during the quarter, consisting of $16 million in capital expenditures, primarily for maintenance and $17 million for expansion of an EI project in the Eastern Hemisphere that will be accounted for as a finance lease. Enerflex also returned $2 million to shareholders in Q3 through dividends. We exited the quarter with net debt of $692 million, which included $95 million of cash and had available liquidity of $588 million. In October, Enerflex redeemed $62.5 million of its 9% notes due October 2027. The redemption was completed at a price of 103% and funded with available liquidity, which includes cash and cash equivalent, and the undrawn portion of Enerflex's lower cost $800 million revolving credit facility. We expect the ongoing interest savings associated with the notes redeemed will materially exceed the redemption premium paid. As a result of our continued focus on financial discipline and operational execution, we have repaid $268 million of debt since the beginning of 2023 and now reached our target leverage range of 1.5x to 2x. We expect to make further progress in coming quarters and remain committed to lowering net finance costs and optimizing the company's debt stack. In line with our efforts to maintain a healthy balance sheet and optimize operations, we are revising our guidance for capital spending in 2024 to $80 million to $90 million compared to previous guidance of $90 million to $110 million. We continue to deploy selective growth capital to customer-supported opportunities in the U.S. and Middle East that are expected to generate attractive returns and deliver value to Enerflex shareholders. While Enerflex continues to develop its capital spending plans for 2025, the company expects growth capital will remain below its long-term historical average. Similar to 2024, continued disciplined capital spending will focus on customers afforded opportunities in the U.S. and Middle East. Further details will be provided in conjunction with the release of the company's full year 2025 guidance in early January. Providing meaningful returns to shareholders is a priority for Enerflex. With the company now operating within its target leverage range of bank adjusted net debt to EBITDA ratio of 1.5x to 2x. Enerflex is positioned to expand its capital allocation priorities to include more direct returns to shareholders. This is reflected in the Board of Directors decision to increase the company's quarterly dividend by 50%. The increased quarterly dividend of CAD$0.0375 per share is payable on January 16, 2025, to shareholders of record on November 26. Going forward, capital allocation priorities could include further increase to the company's dividend, share purchases, disciplined growth capital spending, and or further repayment of debt that would help lower net finance costs. Allocation decisions will be based on providing most attractive shareholder returns and measured against Enerflex's ability to maintain balance sheet strength. I want to thank all Enerflex employees for their great efforts in delivering another strong quarter. I will now turn the call over to Marc for closing remarks.

Thanks, Preet. We're proud of the operational, financial and strategic progress made in recent quarters and remain focused on our key objectives of, one, enhancing the profitability of core operations; two, simplifying our operational and geographic footprint, and three; maximizing free cash flow to strengthen our financial position and enhance shareholder returns. I look forward to building on our progress to create significant value for shareholders. I will now hand the call back to the operator for questions.

Thank you. [Operator Instructions] Our first question comes from Aaron MacNeil with TD Cowen. You may proceed.

Hey, good morning all. Thanks for taking my questions. Marc, I can appreciate that in Preet's comments he sort of highlighted that Enerflex could look at a whole host of different shareholder returns. But since you started to make that pivot, I've got a couple specific questions. I guess one, how often do you think you'll evaluate the dividend? I know historically it's been annually. What's your ultimate target shareholder return over time? And is there the potential that we could see a change in the target leverage range or is it appropriate to just assume that shareholder returns are enhanced as you sort of trend towards the bottom end of that range?

Thanks for the question, Aaron. I wouldn't -- we are happy with our target leverage range of 1.5x to 2.0x. It's our intention and indeed our priority to enhance those returns alongside further debt reduction in the coming quarters, but I think it would be premature to speculate or to provide any long-term guides to that end.

Fair enough. You mentioned that you're going to look at selectively expanding the U.S. contract compression fleet. Could you just give us a bit more context in terms of the potential quantum in terms of total horsepower adds, and then to the extent possible, share what a hurdle rate might look like, as well as sort of minimum contract duration terms.

Yes, Aaron, we'll provide further guidance in the first week of 2025 as to our capital spending plans for that year. We would expect maintenance capital for the whole enterprise to be pretty -- 2025 will be pretty similar to 2024. And we'll provide further guidance on growth cap expenditures for 2025, in January. And we don't have a certain horsepower we're looking to add. What we're really looking to do is make investments with our best customers and the best equipment that provide the best long-term returns for Enerflex. And in the prepared remarks, we did -- we took some -- it was important for us to point out that any new growth capital that we've deployed in 2024, which has been modest and disciplined, they've been deployed under multiyear contracts. And indeed, the contracts that we're getting in the contract compression business in the last tranche of capital we spent have all been in excess of 4 years initial term, which is 2x or 3x longer than what you would have seen a number of years ago. So, the returns on that product is well in excess of what it was a number of years ago, primarily because the landscape for that asset class has gotten a lot better in the last number of years. Demand has gone up. Supply has been consolidated really amongst three big public companies. And we've benefited from an improved revenue profile and contract term profile for those assets. So I think that's the really appealing parts of that asset class. And as far as the quantum and any long-term goals, we'll look forward to talking to the market a little bit more in the first week of January on that front.

Makes sense. Thanks, Marc. I'll turn it back.

Thank you. [Operator Instructions] Our next question comes from Tim Monachello with ATB Capital Markets. You may proceed.

Thanks very much. I just want to understand a little bit around the capital return strategy and the decision to go with a sort of token dividend increase versus an NTIB [ph]. Is that a reflection of just trying to preserve capital considering, I mean, assuming it's an NTIB, it would cost a lot of money or is there other considerations there?

Tim, hi there. It's Preet. I mean, now that we're in the target leverage range, our priority is to enhance shareholder returns alongside further debt repayment. What we're at 1.9x between 1.5 to 2 and the first good step we felt with Board approval is an increase in the dividend to CAD$0.0375 per quarter. So going forward every quarter we'll continue to look at our key financial priorities, look at financial position, balance sheet, health and leverage, free cash flow, and also visibility into our sustainable revenue streams going forward both sides or all sides of the business. And then look at the different levers, continued dividend versus share buybacks, growth CapEx, Marc already talked about, we'll put some messages out early January, very disciplined approach in growth CapEx and maintenance CapEx next year as we did this year. And also for the debt reduction, that's still a high priority. So every quarter we'll look at the different levers, balance with where we are from a financial position, balance sheet, P&L and cash flow, and we'll make some calls on a quarter-by-quarter basis. So, that's the -- that's kind of the next little while. I mean, January and end of February, we'll advise again. But we feel good about this initial step with the dividend, and we've got the other levers to consider every quarter as we move forward.

Okay. That's helpful. On the engineered [indiscernible] energy infrastructure side of the business, we saw a nice uptick in gross margins in the quarter to the low 60s from the mid-50s on a year-over-year and quarter-over-quarter basis. How should we think about that? Is that something we should expect going forward?

Hi, Tim. It's Jeff. There's really three things to reference there. The first is we had some higher overhaul work, especially in the Middle East during the third quarter. The asset utilization across the EI platform continued to be very strong in Q3. We were also benefiting from some rate increases across a number of the asset bases as well. On a go-forward standpoint, the overhaul is more sporadic and I wouldn't include that in your outlook going forward. Utilization should be fairly steady and normalized, and we do expect the rate increases to largely stay for us as well. So we were above sort of a more typical gross margin range in absolute and percentage terms in Q3, but I wouldn't take the Q3 number and normalize it going forward.

How significant was the overall [indiscernible]?

We can't get into the specifics of it, but it certainly did benefit the margin in the quarter.

So should we think about it somewhere between the low 60s and mid-50s on a go-forward basis then?

We'll step back from providing formal guidance on that, but I think referencing the Q3 number relative to where we've been on a more typical basis in recent quarters is a good reference point.

Okay. And then in the engineered systems business, I'm just trying to get a better understanding of how the [indiscernible] backlog look. There's some commentary suggesting that production -- or, sorry, processing equipment has been, I've seen strong demand, might be a higher margin business line, then sort of weakening demand on the compression side, but then you also mention, and I guess weakening margins on the compression side, but then you mention a mix shift, which is going to negatively impact margins. So I'm just trying to bridge the gap there.

Yes, Tim, this is Marc. We're really happy with the bookings we got in the quarter, maintaining our backlog of $1.3 billion. Within that backlog, there is a significant breadth and depth of products and regions that we're supporting, from power plants to LPG export terminals to [indiscernible] projects, CO2 compression. We delivered some CCS projects in Canada in the last quarter. So, a really good mix. And when we look at the embedded margin, we did indicate in the prepared remarks that we could -- the embedded margin as we look at it is closer to our long-term averages. And that's despite our breadth of products and our -- and geographies, the weak natural gas price in North America, combined a little bit with the effects of consolidation in the Permian Basin and consolidators taking a more long-term view of managing that resource. We'd like to point out that the great results are people delivered in Q3 on ES, that we see that sort of averaging back -- moving back closer to the average that you've seen over the last couple of years.

Okay. And then you've got some nice tailwinds in the U.S. rental compression space, signing some extended length contracts. It looks like pricing is moving higher. But then that contrasts with sort of a weakening view of compression margins on sales. So, how are your customers thinking about compression and the decision to own versus rent? Has that changed?

I don't think it's really changed, Tim. I think a dynamic that we have to pay really close attention to is how the consolidators, especially in the Permian Basin are thinking about infrastructure. I'd say a word I would use right now is purposeful. They're being quite purposeful and they're taking a very long-term view of how to manage that resource and how to best build up the infrastructure to get that resource to market. With several consolidators, we do service and new unit sales, and we provide contract compression services. So I'm happy that we've got the scale and the breadth of offerings to address them no matter where they and how they decide to execute on that infrastructure [indiscernible].

Okay. That's all folks, I'll turn it back.

Thank you. I would now like to turn the call back over to Marc Rossiter for any closing remarks.

Since there are no further questions, I'd like to thank everyone for joining today's call. We look forward to providing you with our year-end financial results in late February.

Thank you. This concludes the conference. Thank you for your participation. You may now disconnect.