Why Flotek Industries (FTK) Stock is a Compelling Investment Case

Artko Capital recently released its Q2 2020 Investor Letter, a copy of which you can download here. The fund posted a return of -11.4% for the quarter, underperforming its benchmark, the S&P 500 Index which returned 20.5% in the same quarter. You should check out Artko Capital’s top 5 stock picks for investors to buy right now, which could be the biggest winners of the stock market crash.

In the said letter, Artko Capital highlighted a few stocks and Flotek Industries Inc (NYSE:FTK) is one of them. Flotek Industries Inc (NYSE:FTK) manufactures and markets downhole equipment and specialty chemicals. Year-to-date, Flotek Industries Inc (NYSE:FTK) stock lost 26.5% and on August 6th it had a closing price of $1.49. Here is what Artko Capital said:

"Flotek (FTK) – Flotek continues to be a significant part of our Core Portfolio, whose representation changes from 8% to 14% as its price recovered to over a 150% from its March 2020 lows. Our original thesis on the stock was that the company, that at one point was trading at 30% to its liquid balance sheet values of cash and Net Working Capital, had an incentivized board that would force significant value creation via stock buybacks or outright liquidation. In fact, given the significant energy market implosion in the spring of 2020, we felt our thesis was much likelier to come to fruition as it was apparent that the rig count based business model into which the company sells its enhanced oil well recovery chemicals was unlikely to come back. We were initially somewhat dismayed that the company opted to hire John Gibson Jr, one of the most respected industry veterans, as CEO and Chairman of The Board instead and focus the strategy on using the $100mm+ cash pile to acquire more companies, which at the time we felt was an imprudent use of capital. However, as we have had the opportunity to have numerous conversations with Mr. Gibson and to hear his strategy and thought process, as well as learn about his background and watch him quickly make value creating moves we have decided to stick with our investment albeit at a changed thesis.

Mr. Gibson Jr, quickly recognizing that the old business model is dead on arrival and the volumes of the past were not coming back, renegotiated the supply agreement, based on old volume projections, with Archer Daniels Midland that bought the company’s Florida Chemical division, for an up front payment of $15mm that significantly reduced a much higher cash burn had the agreement remained in place. Soon after the company made a splash by purchasing JP3 Measurement for $36.5mm for a combination of balance sheet cash and shares. JP3’s product is a measurement technology that allows for operators to obtain real-time ( < 30 seconds) data on the composition and physical properties of hydrocarbons across a variety of upstream, midstream, downstream, and distribution use cases. The data is predominately used by operators to assist in process optimization efforts and boasts a diverse range of applications. The company has grown impressively in 2019 with only 3 full time sales staff and despite an upstream market pullback by focusing on the downstream market, including a milestone deal with Phillips 66, a deal we strongly suspect was brought together by Mr. Gibson himself.

So where does that leave us today? While the stock price has surged in July 2020 close to our cost basis and significantly above our spring 2020 additions, the company, at a $110mm valuation still has, by our estimates, $70mm in cash and $10-20mm in other liquid assets. The legacy chemicals business whose $80mm revenue run rate that is 50% below its peak, is likely to shrink even further and we envision it being significantly smaller but with higher gross margins and longer term contracts, with the worst case scenario the entire division being sold for patent value and/or a years worth of gross profit value in the $10-20mm range. There is of course the optionality that oil comes back and the division grows and penetrates the less rig count dependent Enhanced Oil Recovery market segment enough to have a viable economic value again but for now we believe it is priced as a free option within the business. So our real investment here, at the balance sheet price, for the ability of a very incentivized and experienced CEO and Board to grow the JP3 business into its $1b Data As A Service (DaaS) Total Addressable Market (TAM), from ~$14mm in revenues last year, with already significant hires on the business development team and with more on the way, using the CEOs extensive network to strike Phillips 66 type deals. We also expect one or two more JP3-like deals on the way to completely transform the company from an old school chemicals provider to a more high growth energy tech firm with high growth and recurring revenues. With the market still not pricing the stock above its balance sheet values, we believe the JP3 business could be worth more than double the stock price today and with significant optionality on the recovery of the chemicals business and additional successful deal wins. We are excited to see what happens from here over the next few years and feel comfortable with our downside and upsides from here to keep Flotek as one of the top positions in the portfolio."

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In Q1 2020, the number of bullish hedge fund positions on Flotek Industries Inc (NYSE:FTK) stock decreased by about 11% from the previous quarter (see the chart here), so a number of other hedge fund managers don't seem to agree with Flotek's growth potential. Our calculations showed that Flotek Industries Inc (NYSE:FTK) isn't ranked among the 30 most popular stocks among hedge funds.

The top 10 stocks among hedge funds returned 185% since the end of 2014 and outperformed the S&P 500 Index ETFs by more than 109 percentage points. We know it sounds unbelievable. You have been dismissing our articles about top hedge fund stocks mostly because you were fed biased information by other media outlets about hedge funds' poor performance. You could have doubled the size of your nest egg by investing in the top hedge fund stocks instead of dumb S&P 500 ETFs. Below you can watch our video about the top 5 hedge fund stocks right now. All of these stocks had positive returns in 2020.

Video: Top 5 Stocks Among Hedge Funds

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Disclosure: None. This article is originally published at Insider Monkey.