Ben hopes Akita knows the drill

Benj Gallander and Ben Stadelmann
Thursday, August 25, 2011

The recent manic market activity has stoked investors’ fears of a replay of the Great Bear of 2008. Leaders have been slow to accept that the cure for a debt hangover is not to go on a permanent binge.

Despite the wild swings in sentiment, it is worth remembering that the difference between a shallow recession of 1 percent contraction and anemic growth of 1 percent is not so great. That sort of sideways-trending economy is exactly what occurred in Japan during its “lost decade,” and at this point both the US and Eurozone appear to be heading in that direction.

One upside of the market turmoil is it helps shakes loose shares in tightly held, high-quality companies. Such was the impetus when Ben purchased Akita Drilling at $10.30 per share. This Calgary-based drilling company has been a perennial thin trader, out of sync with its fine reputation in the industry. And though it is a small enterprise compared with the likes of Precision Drilling, with annual revenues of $136 million and 800 employees, it’s no hobby farm, either.

Nonetheless, you won’t find a bullboard for the company on, and only one lonely analyst provides coverage. Why so ignored? Akita’s main “problem” is that it is conservatively managed and makes few requests for services from the financial community. Despite being in a capital-intensive business, there is no debt; in fact, the corporation’s credit line was given up because it wasn’t worth the standby costs. Akita has no debentures, preferred shares, or flow-through shares, preferring to fund all expenses independently with cash flow.

The dual-class share structure may also be a turnoff for some institutional investors. In theory, and sometimes in practice, the concentration of voting power weakens corporate governance. But we’ve encountered plenty of single-class public companies where the CEO acts like a proprietor rather than an employee, while the board of directors is packed with cronies whose chief occupation is scratching each other’s backs.

What is more important than share structure is corporate culture and the quality of the folks running the show. One indicator of that is a company’s annual report. Akita’s is a pleasure to read: clear, concise and written in plain English. One handy feature is a fold-out 10-year financial review that tabulates the key metrics over the long haul. This historical perspective is especially important for a firm in a cyclical industry.

For drillers, after 2006 that cycle was sharply down. Throughout this period, Akita remained profitable on an annual basis, though net earnings dwindled from $33.7 million in 2006 to $5.7 million in 2010. Late last year the corner was turned, and results for the first two quarters of 2011 appear to validate that trend. For the six months ended June 30, revenue climbed to $89.1 million from $60.3 million in the corresponding period last year. Crucial was a strong rebound in rig utilization across the sector, with Akita’s 46 percent rate above the industry average of 44.7 percent.

A key factor in this improvement has been the conversion of conventional rigs into pad rigs, which are more mobile and suited for drilling multiple wells in close proximity. These types of rigs are in high demand for heavy oil and shale gas targets. Stubbornly low prices for natural gas have sapped the appetite for deep capacity equipment.

However, rig conversions come at a high cost. Akita has had to ramp up capital spending dramatically to adapt to the petroleum industry’s needs. If that pace accelerates, the company may be put in the unusual position of having to put on a suit and get friendly with bankers.