Aris Water Solutions, Inc. (NYSE:ARIS) appears richly valued at current prices, trading at 18X earnings. The stock has been a “darling” of Wall Street for some strange reason since its IPO, trading at substantially higher multiples than its competitors, Select Energy Services, Inc. (WTTR), for example.
I wrote them up in the middle of last year with a favorable rating, but the company is now 20% lower than it was then. A fact attributable more to the oil price sag, malaise that’s kept the microcaps like ARIS and WTTR from realizing the gains seen by the big colors, than a problem with their business model per se.
ARIS price chart (Seeking Alpha)
It’s time to face facts. ARIS has been a dog, going essentially nowhere in 2022, and not giving much sign of moving higher so far in 2023. Will it remain a dog? That is the question we will address in this article. The stock still has the backing of Wall Street, which is willing to assign them an overweight rating at 18X earnings and 9.5X EV/EBITDA, with a price target as high as $24 per share.
What are the analysts seeing that has them allocating higher multiples to ARIS than Halliburton (HAL) – now trading at 13X earnings, and 8X EV/EBITDA? Let’s have a look to see if we can find a reason for this bullishness.
The thesis for ARIS
ARIS is exclusively focused on the Permian basin, as shown in the map below. Specifically, the best part of it in terms of activity in Lea and Eddy counties in New Mexico, and the Northern section of Loving county in the Delaware basin, and Martin, Howard, and Midland counties of Texas in the Midland basin. Those counties account for over 230 of the 350 or so rigs operating in the Permian.
ARIS footprint (ARIS)
Unlike competitors WTTR and TETRA Technologies (TTI), ARIS is a water management pure play. Their business is spread equally over the frack water flowback and cleanup, and the produced water business.
Produced water is the long-term driver in this business, as it involves taking this water to million barrel impoundments for cleanup and conversion to frac water, or, on the horizon, desalinization to a near-fresh standard for potential agricultural use. West Texas is a desert with most fresh water sources coming from underground aquifers that are being drawn down much faster than the sparse rainfall in this area can replenish. Desalinating water from oil wells is a huge opportunity to obtain a new source of fresh water and minimize the use of disposal wells. This form of disposal is coming under increasing scrutiny as seismic activity in the Permian basin becomes more pronounced. Earthquakes are not common in the Permian, and their increasing frequency has drawn the attention of regulators.
ARIS Services scope (ARIS)
Their capacity to treat nearly 3 mm bbls daily is big driver for their business and helps to draw commitments from large generators like ConocoPhillips (COP) and Chevron (CVX). A point worth noting and on which we will expand upon in the wrap-up section is these commitments are driving capex as the infrastructure is built out to handle the water volumes. So far there is no income being generated, but that will change later this year. Amanda Brock, President of ARIS comments on monetization of these assets-
When we did the Chevron transaction and we indicated that we were going to be spending approximately $50 million to $60 million, we also indicated that there was a lag of about six months to nine months until we would see the benefit of those volumes. So, you will see more volumes coming into the system from Chevron next year as we complete all of the hookups and the infrastructure needed.
So, better days are ahead on the revenue front.
Long-Term Catalysts for ARIS
Obviously, the long-term contracts with Chevron and ConocoPhillips are transformative. These are strategic, meaning that the companies are going to be working together on a number of water-related initiatives. (Press release.) Amanda Brock, CEO, comments on the broad outlines of these agreements:
We are also pleased to announce our strategic agreement with Chevron and ConocoPhillips to jointly focus on advancing opportunities for beneficial reuse. Together, we will identify, develop and pilot proprietary and differentiated technologies for potential applications in non-consumptive agriculture, low-emission hydrogen production and direct air capture of atmospheric CO2.
Something this tells us is that as we close out 2023, among other things, ARIS’ water processing volumes likely are going higher. And, that brings additional scale to the company with probably the most volumes in the industry.
ARIS 3rd Qtr Highlights (ARIS)
Next we have the technology agreement with Water Standard, a privately held diversified water treatment equipment manufacturer, and high technology filtration equipment to include reverse osmosis and nanofiltration. While the details of this technology agreement were not disclosed, Water Standard makes just the type of equipment that will become useful in these partnerships with CVX and COP.
Water Standard advanced technology (Water Standard)
Additionally, they have brought a technology transfer steward into the fold with the hiring of Lisa Henthorne as Chief Scientist from Water Standard. This is the way to bring on new technology from outside. If it comes without a champion who understands it and has the authority to move key initiatives forward, it can languish.
Finally let’s not forget the underpinning of all this interest in water reclamation, hydrogen production, and carbon capture. The Inflation Reduction Act of 2022, provides direct funding and tax credits more many of these initiatives. Future revenue streams will be enhanced from government largesse for many years.
Q3 2022 Results
Revenues grew 20% QoQ to $90.5 mm, while EBITDA rose a modest 8% to $35 mm. A one-off working capital build related funding newly acquired major contracts contributed to this result. LT Debt stood at $393 mm with cash at $25 mm. Liquidity stood at $165 mm inclusive of their RCA which is being tapped to help fund the Chevron buildout. ARIS is also paying a small, $0.43 dividend on an annual basis, currently yielding 2.7%.
Guidance for 2023
Stephan Tompsett, CFO commented on the outlook for 2023-
Recent industry reports and initial production targets from some of our large customers indicate 15% to 25% year-over-year oil production increases in the areas in which we operate for 2023. We expect to grow alongside this increasing production and look forward to providing an update to our 2023 outlook when we provide our fourth quarter ‘22 results.
I don’t see a lot downside for Aris Water Solutions, Inc. stock. Their core business-frac and produced water treatment is programmed for growth. Particularly produced water and derivatives that come from the just beginning initiatives. This business is not tied to rig count.
The primary risk I see is continued dead money as investors shun the stock, tying it to the rig count. This risk should diminish as volumes increase during the year as previously discussed.
Let’s understand something, water is precious and becoming scarcer. The map below from the Drought office of the U.S. government is illustrative. This has real world implications for many U.S. cities. They are running out of water.
Drought monitor (Drought.gov)
Against that context, the steps ARIS is taking to tie up big volumes of water start to make sense. It also perhaps gives us a look into how analysts may be viewing the company and giving it a higher multiple than they would for a company with strict oilfield prospects. ARIS has clearly set its sights on a bifurcation into a more technological approach to water management.
If you can see past the next couple of quarters, ARIS might be a good bet for growth. They are shedding their oilfield startup status, and appear to be on track to be valued as a technology player in the environmental space, like Clean Harbors (CLH), trading at 13.5X forward EV/EBITDA, or recently acquired at 28X earnings Evoqua Water Technologies, (AQUA) and 18X EV/EBITDA by Xylem Inc. (XYL) itself trading at 23X EV/EBITDA.
Multiples get higher the farther you go from the oilfield! (Now, I still don’t think they rate a higher multiple than Halliburton-which is also a tech company, but that’s life.)
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