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In October of last year, I concluded that Aris Water Solutions (NYSE:ARIS) was a growth play in a long-term contracting market. The water and recycling services offered by the business, predominantly to oil and natural gas producers, were in solid demand with energy producers forced to meet ESG goals as well, as the long-term outlook for this business can be debated of course.
Despite solid growth and profitability reported at the time, I feared the high valuations for the business which went public nearly a year ago, as high valuations and a capital-intensive business model made me cautious, alongside some other concerns.
IPO Recap
Aris has been based on the idea that shared water and recycling infrastructure can create better stewardship for the environment in an economical fashion. The focus on innovation and technology made that the company helps (energy) customers to reduce water usage and reduce their carbon footprint.
The core locations are located in the Permian Basin, include full-cycle water handling and recycling solutions, with all the major energy producers being the customer of the business. Other applications include agriculture and industrial applications.
At the time of the IPO, the company had 640 miles of pipelines (by now over 700 miles), connected to nearly 50 handling facilities which can process over a million barrels of water a day, as further growth in the Permian oil production left significant room for further growth of the operations.
The company went public at $13 per share, far below the middle of the preliminary pricing range of $17 per share. At $17, the company would be awarded a $910 million equity valuation, or $1.27 billion if we factor in net debt. This was based on a business which posted $81 million in sales and $13 million in operating profits in 2019. Revenues rose sharply to $142 million in 2020, as operating earnings fell to $8 million.
With revenues trending at $200 million a year in 2021, based on the results in the first half of the year, operating profits were very strong at $18 million in the first half of the year. Based on a $36 million operating profit (run rate) number, I pegged net earnings at just half that, or $0.30 per share, which translated into a huge valuation multiple.
With capital spending combined surpassing $300 million in the years 2019 and 2020, this resulted in huge cash outflows as deprecation charges trend at just $60 million per year, and some abandonment charges were taken as well.
The irony is that growth of oil production was actually driving the business in the short to medium term, yet a change to renewables in the long run might actually hurt the business. With competition, availability constraints, customer concentration, high valuation multiples and poor cash flow conversion being all major headwinds, I did not see a compelling risk-reward at the time.
A Recap
Following the IPO, shares initially fell to the $10 mark earlier this year, rose to a high at $23 this past summer, and now trade at $15 and change again, near the IPO price.
Earlier this year, the company posted fourth quarter revenues at $67 million, for a run rate of $270 million. The company posted operating profits of $14 million for the quarter, a solid result, as that could reveal upside to the $0.30 per share earnings number estimated at the time of the offering. The company guided for 2022 EBITDA at a midpoint of $155 million, with capital spending pegged at $80-$90 million. With net debt reported at $340 million, the situation looked manageable from the leverage point of view, certainly in the light of higher profits.
The company announced a deal with Chevron during the first quarter as first quarter sales rose further to $71 million as a flat operating profit was posted, after taking a $15 million impairment charge on long-lived assets. The company hiked the EBITDA guidance to $170 million following a solid quarter, yet capital spending guidance has been hiked in a major way to $140-$150 million as well.
Second quarter sales rose further to $76 million as operating profits came in at nearly $12 million, even after a $5 million cost related to abandonment of wells. The company posted adjusted net earnings of $12 million and after backing out $3 million in stock-based compensation, realistic earnings trend around $35 million a year which reveals that earnings come in around $1.50 per share. That is quite solid, certainly as net debt of $365 million is very manageable given the growing EBITDA numbers and the continued net investments into the business.
What Now?
Truth is that I am a lot more upbeat on Aris now than I was at the time of the IPO about a year ago. Sales are trading largely flattish, yet have shown quite some volatility over the past year. The biggest change is solid operating momentum in terms of sales growth translating into solid earning growth. Consequently, earnings which now trend at $1.50 per share come in far above the $0.30 per share estimated by myself at the time of the offering, a huge positive surprise.
Amidst all of this, I think it is time to become a bit more upbeat on Aris, because the company is seeing benefits from great focus on ESG and water scarcity as well. On the other hand is the argument that this is an asset intensive business which makes growth capital intensive and competitive, yet a small long position seems warranted here given all of this.
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