In times of uncertainty, lean into field fundamentals (and valuation). There were two key, but distinct negative takeaways from last week’s 2Q19 result. First, fleet profitability retreated, and the N-T utilization outlook softened. Second, the company announced an Audit Committee review of potential controls deficiencies, which discovered that “incorrect expenses” were filed by the CEO/CFO (albeit in amount of a G&A rounding error). We understand the selloff, as investors remain in “wait and see” mode regarding audit findings. Rather than retrench to this holding pattern, we are leaning into field fundamentals, and believe that valuation (now below equipment replacement) encapsulates the audit overhang. We reiterate OP, and lower our YE19 PT to $27 (from $33) based on 5.5x our FY20 EBITDA.
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CHOW – OFS exposure by operator, 2H19 spending, and potential revenue impact. Building upon our E&P capex-themed charts from the past several Rumblings, this week we attempt to frame the 2H completions slowdown by determining pumper-specific exposure to each operator. Combining E&P capex guidance and Rystad completion data, we calculate the potential revenue impact and percentage fall-off from 1H19 levels (ex-price/efficiency fluctuations). Given a high percentage of “unallocated” E&P completions (i.e. OFS unknown), the chart may underserve market share volatility and pumper exposure to a particular E&P. Nevertheless, well-tabulated FracFocus records for HAL (larger 2H falloff) and SLB (modest falloff) show somewhat divergent trajectories as the broader frac complex braces for activity to decelerate. Please reach out for further explanation of the methodology/results.
Results underwhelmed street expectations, as PUMP dropped a crew in the quarter and annualized EBITDA/spread fell to $15.6M (inclusive of fluid ends, from $19.0M in 1Q). Fleet profitability is still among the top of the peer group, but 25 spread guidance for 3Q falls a crew short of prior consensus. However, market focus will be on the extenuating circumstances around CEO and CFO conduct and the Audit Committee’s finding of “incorrectly recorded” expense items. Depending on Audit Committee findings and subsequent disclosure, potential CEO/CFO misconduct could not only negatively impact PUMP’s relationships with existing customers (currently rooted with the CEO), but could also reverberate across a NAM OFS sector that is already perceived to be structurally impaired. We reserve additional analysis until further disclosure regarding Audit Committee findings (likely within 30 days).
Our take – A light in dark places, when all other lights go out. From the first line in our 1Q EPS note – “In an otherwise dismal tape for OFS equities, NESR quietly printed another solid 1Q19 result”. Flash forward to today, another solid result will likely see a rare consensus estimate raise (against an even more depressed OFS backdrop than a quarter ago). The 2Q EBITDA beat was an important result for those investors wary of recent margin lumpiness and continued profitability bleed (a symptom of regional/segment expansion, although still subordinate to topline growth for the NESR thesis, in our view). While margin lumpiness could persist as NESR accelerates growth through 2H19, we note that consistently solid execution through the first year as a public company also lends further credence to MENA as the healthiest among the global OFS regions (an idea perhaps underserved by commentary from larger, diversified and more mature peers). Share liquidity remains the primary issue for NESR equity, and continued sector UP has driven even more of the market away from OFS. NESR remains the L-T int’l play. We maintain our OP rating and YE19 PT of $22 (unch – street high), based on 9.0x (unch) our FY20 EBITDA of $245M (up from $241M – also street high).
We led off 2Q OFS earnings with an update on our US shale productivity thesis, calling out a near-term Permian productivity peak as E&Ps shift fully to pad development. So far, CXO’s Dominator spacing test has (appropriately) dominated the Permian discussion, and our E&P colleagues have covered and spoken extensively on the topic. For OFS, the most important implications go beyond Permian acreage inventory/M&A. For NAM OFS, well/stage up-spacing could offset continued per-rig and per-frac crew efficiency gains (positive for domestic OFS demand). For global OFS, a peak/inflection in US shale productivity, particularly in the context of the low-growth E&P framework, could be a stabilizing force to supply-side oil broadly (predictability from which could stimulate int’l activity with better OFS earnings power, key for SLB, HAL, BHGE and investability of the sector).
NESR reported 2Q19 earnings this morning and is hosting a conference call to review results today (08/07) at 9am ET (8am CT).
2Q19 EBITDA was slightly below consensus as margins compressed ~150bps q/q and fell below 20% for the first time since 1Q19, an underwhelming result despite well-telegraphed USL rig count declines. Given recent share/RigDirect expansion in the L48, NAM friction will perhaps have a more pointed impact on TS than previously thought, as OCTG/consumables don’t have the same int’l pricing leverage as other OFS. Our estimates have been revised downwards due to these frictions, while incrementally bullish int’l/offshore commentary from OFS peers should help stabilize FY20 – growth of 8% and 35% incremental EBITDA margins still seem appropriate, and continued working capital tailwinds (execution of which has been solid) could see 20% FCF growth as well. Maintain TS Peer Perform with $31 YE19 PT based on 9.5x FY20 EBITDA, until further evidence of offshore earnings power breaks more static pricing ests.
The near-term outlook is remarkably clear for BHGE’s OFS segment – NAM friction will be minimal given lack of pumping exposure, while there is still plenty of int’l runway (beyond a burgeoning, multi-year organic growth cycle) to continue to take share and drive outsized margin expansion. TPS is on track to accelerate through YE19 into a prolonged liquefaction buildout (link), and OFE margins continue to grind higher (despite some lumpiness). Working capital execution is already excellent, but the company expects continued improvement and we see appreciable FCF growth in FY20. The most difficult task, then, is to comp/value BHGE relative to primary peers based on its differentiated exposure outside of traditional oilfield services. On the NTM EBITDA front, we are comfortable with the 10x FY2020 EBITDA driving our YE19 PT of $34 (a premium to HAL 9.5x) given the duality of OFS share growth in both int’l and NAM. On the FCF yield front we’re comfortable with the 3.5% FY20 yield (a premium to SLB 4.5%) given the nascence of the OFE/TPS-LNG cycles. Valuation premia isn’t based on “late cycle”, it is rooted in “different cycle” for BHGE’s unique, non-oil exposures. We maintain BHGE Outperform with YE19 PT of $34 (up from $33).
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