From Fairmount Santrol (FMSA – NC) to Preferred Sands (private company) to Black Mountain Sand (private company), we continue to see more newbuild frac sand mine announcements. FMSA announced a new Mid-Con mine on their 1Q18 conference call earlier this month (avid readers of the Morning DEW were aware of the permit filed back in April). In addition, Preferred Sands has filed new permits in the Mid-Con and the Eagle Ford basins in the past two months. And more notable, Black Mountain Sand announced this week at an industry conference the company will not only be adding more capacity in the Permian (2mm TPY of brownfield + 2-3mm greenfield) but also entering the Eagle Ford and Mid-Con frac sand markets. The Eagle Ford mine, however, is not incremental to our list as we already included this permit (Western Silica). We’d be surprised if this was the last of incremental capacity announcements.
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Lots of debate amongst pressure pumping companies and investors these days. The bears point to the potential 4.5-5mm HHP set to enter the market this year, while the bulls see this incremental supply absorbed on an optimistic outlook for attrition and demand. We sit closer to the middle, not bullish but not uber bearish either.
US unconventional oil production now increasing 1.3 MMBopd y/y. According to the EIA’s Drilling Productivity Report (DPR), US unconventional oil production for the 5 major US oil producing basins has reached approximately 6.5 MMbopd, almost a 1.0 MMbopd above ‘14 peak levels and now up about 1.3 MMbopd y/y, which is comparable, on an absolute basis, to peak year-over-year growth levels reached during 2014. We expect this pace of growth to continue, with US unconventional oil production exiting the year up 1.4 MMbopd y/y.
$1bn operational improvement by YE19. We are still a bit confused as to the baseline for the $1bn of operational improvements. Is it 3Q17 EBITDA of $163mm, as originally thought, or is the starting point really 4Q17, after which EBITDA collapsed sequentially by almost $100mm? This matters. If it’s 3Q17, the $725mm of annualized cost savings (remaining $275mm more related to share gains) would actually imply an adjusted 3Q17 EBITDA margin of 23.1%, ahead of every other peer’s 4Q17 EBITDA margin (SLB [OP] = 22.5%, HAL [OP] = 19.6%, BHGE [OP] = 12.6%). However, using WFT’s much lower 4Q17 EBITDA of $70mm as a starting point, $725mm of cost savings would imply a more reasonable adjusted EBITDA margin of 16.9%, putting WFT somewhere between HAL and BHGE.
Following a 25% surge in the OSX since mid-Dec, outpacing the S&P 500 by 18%, the OSX has pulled back 5% in the past week. We believe near-term the path is still higher, assuming oil prices hold near $60/bbl. Longer-term, however, we remain concerned regarding deflationary forces. Our favorite subsector, diversified services, actually provides a natural hedge to this deflationary risk since they are enabling this deflation through technology penetration in the oilfield. On the flip side, we would avoid all commoditized, low barrier to entry businesses, like pressure pumping and frac sand.
We conducted our 1st quarterly OFS investor survey, with the overwhelming majority (69%) expecting OFS to outperform in ’18. Only 16% see underperformance. In ‘17, the OSX was -19%, a big divergence vs the S&P 500 (+19%). See note for detailed results and opinions on all 12 survey questions. Thanks again to all 104 participants!
1Q cash burn was -$19mm, increasing from 4Q (-$12.9mm) on lower Net Income (1Q/4Q = -$31.3mm/-$29.8mm) and working capital/other (1Q/4Q = -1.0mm/+$4.1mm). Management continues to expect breakeven CF by YE17. Further, CARBO should receive $12.3mm mid-’17 after refinancing its prior term loan.
‘17 will be good. ‘18 bad (relative to Cons) and, if so, OFS valuations are ugly (Exhibit 7). We reiterate our thesis that the Age of Optimization will be characterized by enhanced volatility, both oil prices and service activity. We expect another 50-100 HZ rigs added over the near-term, followed by >100 rig decline into mid-‘18. 700-800 total HZ rigs (current=706) are sufficient to grow US unconventional oil production at annual clip of 0.5-1.0MMpd, adequate growth to keep global oil markets balanced over the next 2-3 yrs. So we struggle to see meaningful upside to US service activity from current levels. Maintain MW on OFS sector, favoring Diversified Services (MO) over offshore (MW) & onshore (MW) subsectors. Downgrading FET and RES to PP.
Wavering OFS stock performance recently, with the OSX/OIH down 6%/5% in the past week, underperforming oil prices (unchanged) and S&P 500 (-1.3%). Maybe it has something to do with 40+ Hz rigs (~85% oil) added over the past 2 weeks, bringing the total Hz oil rig additions to 215 (250 total oil rigs) in the past 8 months. The pace of rig additions must slow materially (+10 Hz rigs per week over last 4 months); otherwise, we are potentially heading for sloppy 2H for OFS stocks.
Better than expected results and near 50% short interest drove CRR up 35% (OSX -4%) over the last couple of days as 4Q EBITDA of -$16.3mm, which includes $5-6mm of slowing & idling cash costs, was mostly in-line with Cons/WR of -$15.8/-$13.1mm. New technology and frac sand will be the key drivers in generating positive EBTIDA by YE17 (we model 4Q17 = -$4.4mm EBITDA). Our 2017 y/y revenue growth of 64% is above guidance for 40-50% y/y growth, with new technology up ~75% y/y, accounting for ~30% of total ’17 revenues (3Q16 call indicated 25-30% new tech sales in ’17), and sand revenues up 292% y/y (7% of ’16 sales to 17% of ’17 sales). Turning to FCF, we expect 1Q17 FCF of -$23.2mm (higher burn on inventory build) and 2017 FCF of -$38.9mm, with 4Q17 showing positive FCF (+$3.9mm). Liquidity looks sufficient in 2017; however, in 2018, we expect the company may need to either refinance the term loan ($43mm in ‘18) or utilize the ATM offering (~$29mm remaining). Maintain PP rating but increasing PT to $15 (7.5x WR ’19 EBITDA) from $11.
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