Saturday, March 15, 2014

Profire Energy ( Nasdaq - PFIE ) -- Burns Rubber

Profire Energy (PFIE $3.50) is the leading provider of automated burner management systems used by oil and gas producers to remove contaminants after the energy is pulled up from the ground.  The products are used, to a lesser extent, in downstream operations to clean up oil and gas while in transit.  Most U.S. wells employ manual systems that require workers to relight a unit if the flame is extinguished.  Profire's machines monitor the burners with computers.  That allows operators to adjust the flame density automatically as the amount of oil and gas increases or diminishes.  The systems also relight the units if they go out.  Canadian regulations require automated units like Profire's to improve worker safety.  Similar rules have not been implemented in the U.S. to date.  Dozens of American workers continue to be blown up every year using the old technology.  A growing contingent of U.S. producers are adopting Profire's automated approach not only to enhance safety, but to improve efficiency and generate environmental benefits, too.

Profire originally was a service company that focused on burners and other oilfield equipment.  The company saw the opportunity to automate the process and developed its own technology in the late 2000s.  Sales initially addressed the Canadian market due to the regulatory tailwind there.  Initial success led to expansion in the United States.  The transition to becoming a manufacturing company wasn't seamless.  Financial performance was inconsistent prior to the current fiscal year (March).  But Profire emphasized product development and customer service despite the ups and downs, enabling it to become the industry leader by a wide margin.  Less than 5% of the potential market has been penetrated to date.  That market is continuing to expand at above average rates as North America becomes the #1 energy producing region in the world.  And Profire is ensconced as the industry leader.  The company holds 65%-70% of the market today, and that figure is continuing to rise.

Growth has accelerated in response to expanding U.S. adoption.  Sales are on track to more than double to $35 million in the fiscal year ended March.  Margins have recovered from last year's decline, supporting a likely 400% expansion in profits to $.15 a share.  Regulatory uncertainty caused a hiatus in Canadian sales for a large part of last year.  Profire also misplayed its sales force expansion in the United States.  The U.S. situation was resolved by the time the current fiscal year began.  That paved the way for the explosion in sales.  The Canadian business has bounced back but remains less vibrant than it might be.  Regulations exist but have been enforced inconsistently, encouraging some drillers to employ alternative (non-automated) solutions.  The lack of pipeline capacity has impacted production in Western Canada, as well.

Geographic expansion promises to sustain growth at superior levels.  Profire covers a small portion of the U.S. market presently.  New offices are being opened at a fast clip in North Dakota, Texas, Oklahoma, and Pennsylvania to provide deeper hands on coverage.  The sales force has doubled over the past six months.  That group promises to make significant contributions in the June period and become fully operational in Q2-Q3.  Relationships with OEMs are being expanded.  About of 25% of sales are made to makers of complete systems that are installed at the well site.  Most of the rest go to installation companies that buy parts from multiple manufacturers and assemble them.  About 25% of sales are retrofits to existing systems.  International sales remain low but distribution channels have been established in Brazil and Australia.  Efforts recently were initiated to enter the Middle East and other high potential international markets.

New products will be introduced on a regular basis.  Profire is upgrading its systems with the latest semiconductor technology to facilitate remote software updates and other performance enhancements.  The line is being extended to more upstream applications, as well.  Several large non-energy industries employ old fashioned burners, moreover.  Profire believes its next generation systems could penetrate those markets, probably in conjunction with resellers that already have the necessary marketing relationships.  Ancillary products are being developed, too.  Approximately 30% of sales are comprised of third party items like valves and regulators.  Margins are good on those sales.  But they will be even better once Profire starts manufacturing them in-house.

Prices may increase in the upcoming fiscal year.  Current units sell for $2,000-$3,000 apiece, depending on the number of features included.  The average well produces $50,000-$100,000 a day in revenue.  Manual re-light systems can go dark for days at a time until a worker swings by and starts up the unit again.  That normally entails putting a lighted rag on the end of a stick, and inserting it into the burner.  Profire's computer based machines are more economical even when the flames don't go out.  Older units keep the flame steady at a high level no matter how much oil or gas is flowing.  The company's automatically adjust, saving energy.  The units also sharply reduce the amount of natural gas that is flared into the atmosphere, cutting greenhouse gas emissions.  Many of the 35,000 new wells drilled each year in the U.S. now use an automated system.  But about 850,000 older wells are still out there with manual systems.

Acquisitions could enhance performance.  Our estimates reflect Profire's organic potential.  But the company is investigating several deals, both in the burner management space and among other types of products that could be sold to the same customer base.  Any transactions within the industry would be made to acquire distribution capabilities.  Profire probably would sunset any acquired systems and transition the new sales force to its existing line-up.

The U.S. retrofit market could surge if safety regulations are implemented.  The industry is moving in that direction due to the high benefits and low costs associated with Profire's units.  But that transition is mainly focused on new wells currently.  If tighter rules are created the company probably would be the largest beneficiary.  That level of adoption also might facilitate international growth.

We estimate sales will improve 40%-55% next fiscal year to $50-$55 million.  Acquisitions could yield upside from there.  Earnings have the potential to reach $.20-$.25 a share.  In 2-3 years sales could achieve $100-$125 million, delivering income of $.45-$.55 a share.  Growth could remain at a high level in subsequent years as North American energy production continues to grow, the retrofit market develops, and international demand becomes a more important element.  Applying a P/E multiple of 20x to the midpoint of the range suggests a target price of $10 a share, potential appreciation of 185% from the current quote.

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