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North American Construction Group: Short-Term Challenges Vs. Medium-Term Stability

NOA Has Many Short-Term Challenges

At the current energy market dynamics in the past-pandemic world, lower capex in the oil sands industry will keep the pressure on the Canadian energy services industry. So, in the short term, I do not expect North American Construction Group (NOA) to show any improvement in performance. Rather, higher-than-expected maintenance time in a coal mine project can set its Q2 revenues and margin at a much lower level compared to Q1.

NOA, which has long-term contracts with some of the largest oil sands producers, should see the top-line and margin stabilizing by the end of 2020. The company’s strategy to diversify into the non-oil business, including operating ultra-class trucks, will offer stability to the cash flows. The company’s balance sheet is not robust. Its leverage ratio was excessively high in Q1, which can be concerning in today’s scenario when the credit market is getting tighter. To survive the downturn, the company needs to follow its stated debt reduction plans and increase cash flows. I think returns from the stock will remain muted in the short term but can increase once the drivers are in place in the energy industry.

The Current Challenges

Let us first discuss the impact of the changes due to the ongoing pandemic in NOA’s operations. Although the oil sands business is barely profitable at the current low oil prices and weak demand, investors may note that it accounted for 75% of the company’s EBIT in 2019 and, so, is still a crucial piece in NOA’s portfolio. Since the company’s oil sands customers have cut down the workforce to maintain social distancing protocol, the company has lost operations in at least one mine site since March. So, its top-line is likely to reduce in Q2. The company expects the process to resume in late-May.

On top of that, the prolonged depression in the crude oil price due to insufficient demand in the energy market worldwide and excess supply has also caused production shut-in and storage capacity issues. Another mining site expanded maintenance turnaround from early May until late June, which, again, will undermine the company’s revenue potential. The mining site where NOA’s operation has stalled ran a production train, and therefore, its services will suffer a second blow from the loss.

Strategic Advantages

Thankfully, NOA’s contracts with the customers have provisions for such exigencies, and the customer can move the committed volumes between operations. So, over the medium term, I think the overall effect on production will be minimal, although most of the adverse effects will reflect in the Q2 results, and the following quarters will improve accordingly.

The company’s truck operation fleet will be relatively resilient. In Nuna Logistics, its activities will be steady as seasonal work typically starts at this time of the year. Investors may note that NOA strengthened its fleet through the purchase of 31 used ultra-class truck fleet from an oil sands producer in…

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2020-06-05 20:40:46

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