Enerflex Ltd. Q3 FY2024 Earnings Call

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 Marc, 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 five 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 five 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 depreciation and amortization 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 depreciation and amortization 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 a 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 the 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 customer-supported 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 the 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. 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 of 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. We are satisfied with our target leverage range of 1.5x to 2.0x. It is our goal and priority to improve those returns while also reducing debt in the coming quarters, but I believe it is too early to speculate or provide any long-term guidance on that matter.

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 will offer additional guidance in the first week of 2025 regarding our capital spending plans for that year. We expect maintenance capital for the entire enterprise in 2025 to be quite similar to 2024. More details about growth capital expenditures for 2025 will be provided in January. We do not have a specific amount of horsepower we plan to add. Our goal is to invest with our top customers and procure the best equipment that yields optimal long-term returns for Enerflex. In our prepared remarks, we highlighted the significance of any new growth capital deployed in 2024, which has been modest and disciplined, and has been done under multiyear contracts. The contracts we secured in the contract compression business from our recent capital expenditures have all had initial terms exceeding four years, which is two to three times longer than what was typical several years ago. Consequently, the returns on that product have improved significantly compared to previous years, mainly because the environment for that asset class has become much more favorable recently. Demand has increased, and supply has been consolidated among three major public companies. We have benefited from better revenue profiles and contract terms for those assets. Those aspects make this asset class particularly attractive. Regarding the scale and any long-term objectives, we look forward to discussing that with the market more thoroughly in the first week of January.

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

Thank you. 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. 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?

Hi Tim, it's Preet. Now that we are within our target leverage range, our focus is on improving shareholder returns while continuing to reduce our debt. We are currently at 1.9x, which falls between our target range of 1.5 to 2. We recently received Board approval to increase the dividend to CAD$0.0375 per quarter. Moving forward, we will consistently evaluate our key financial priorities, including our financial position, balance sheet health, leverage, free cash flow, and the sustainability of our revenue streams across all aspects of the business. We will consider various options on a quarterly basis, such as continuing dividends versus share buybacks and growth capital expenditures, which Marc already mentioned. We plan to maintain a disciplined approach to growth and maintenance capital expenditures next year, similar to this year. Reducing debt remains a top priority. Each quarter, we will assess our financial situation and make decisions accordingly. We expect to provide further updates in January and at the end of February. We are optimistic about this initial step with the dividend and will evaluate other options as we progress.

Okay. That's helpful. On the engineered 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 overhaul?

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.

I'm trying to gain a clearer picture of the backlog in the engineered systems business. There are indications that the processing equipment segment has experienced strong demand and may be a higher margin area, while demand for compression appears to be weakening. However, you've also mentioned a shift in the mix that could negatively affect margins. I’m looking to reconcile these points.

Yes, Tim, this is Marc. We're very pleased with the bookings from the quarter, maintaining our backlog of $1.3 billion. This backlog includes a wide range of products and regions we are supporting, such as power plants, LPG export terminals, and CO2 compression projects. In the last quarter, we successfully delivered some CCS projects in Canada, resulting in a solid mix. When evaluating the embedded margin, we mentioned in our prepared remarks that it aligns more closely with our long-term averages. This is true despite our variety of products and geographical presence, the low natural gas prices in North America, and some effects from consolidation in the Permian Basin, where consolidators are taking a more long-term approach to managing resources. We also want to highlight the excellent results achieved by our team in Q3 in engineered systems, which show some recovery back toward the averages we’ve seen over the past 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 decide to execute on that infrastructure.

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.