Weekly OFS thoughts, including 4Q19 OFS Earnings Scorecard, PD-CA Earnings, and the NESR/SAPESCO deal.
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Yesterday at 10am ET, NESR announced the acquisition of Sahara Petroleum Services Company (SAPESCO) in a cash & stock transaction. With estimated adj EBITDA of $20 million, SAPESCO represents both a geographic & portfolio tuck-in for NESR, a well-timed entry into a burgeoning Egyptian exploration market (on both land & offshore) with access to unique industrial services (pipe cleaning/inspection - SAPESCO had previously helped execute the Zohr pipeline project). The 4.35x EBITDA transaction multiple is accretive (vs. NESR 5.5x currently trading at ’19 EBITDA), with the ~$87M deal consideration comprised of $27M in cash & $30M in debt (both funded with NESR cash/revolver), in addition to the issuance of ~3.0mm NESR shares (based on earn-outs and priced at $10/sh minimum, bolstering the accretion metrics).
Where HP came out this earnings season as an incrementally vocal proponent of performance-based commerciality (PTEN less so, but still engaged), PD-CA seemed more dubious of the potential risk/reward skew. The company noted that it remains “somewhat cautious regarding these pricing models” given heightened driller risk, but that it continues to explore all optys within a rigid economic framework. We tend to agree with this sense of caution, given what we view as limited runway for both the efficiency arbitrage (see MENA LSTK for diversidfied OFS) and E&P appetite to depart from the dayrate model. In our view, PD’s pushback against P-B contracts could also be tied to its AlphaApps success. To us, it makes more sense to recoup the value through discrete, high margin software deployment, than it does to internalize subsurface risk and potentially sacrifice safety/quality for speed.
PD-CA reported 4Q19 earnings this morning (2/13/20) and is hosting a conference call to review results today (02/13) at 2p ET. US drilling drove a 3% topline beat vs. prior consensus, supported by a 4% q/q increase in US rev/day (higher dayrates, idle & tech rev). Canada & int’l revenue fell largely in-line with street, with lower-than-expected utilization days offset by better-than-expected rev/day. PD-CA managed costs well across all three geographic drilling segments on a Y/Y basis, although it is worth noting that the componentization of rig recerts contributed to the opex decline (a one-time accounting change moving forward). Excluding the recerts change across US/Canada, we estimate that adjusted EBITDA would have been ~US$6M lower than the $105M reported figure (still good for a q/q improvement and 12% beat vs. prior consensus). On the other hand, the recert accounting change contributed to modest capex creep on the quarter ($2M for recert alone).
Even as the demand-side macro deteriorates, subsea equipment is slowly turning the corner (OII, FTI-NC). Considering the oil demand destruction wrought by sustained Coronavirus uncertainty, its amazing (to us) that WTI hasn’t traded substantially lower than the key $50/bbl threshold. Perhaps this speaks to better market cohesion on US shale deceleration, especially given the (presumed) negative E&P capex response to <$50 oil…downside risk to USL OFS is real at these commodity levels. This better oil supply visibility also seems to be supportive of longer-cycle offshore spending, commentary around which hasn’t been impacted too harshly by the pullback in crude (since mid-Jan). Perhaps it’s naivety on our part in thinking that subsea equipment will continue to turn the corner, regardless of N-T oil demand volatility (i.e. US shale is no longer swing supply to the upside, but could contract more sharply with oil downside, benefiting E-Hemi investment). Two positive data points from the subsea equipment subsector – 1) OII’s recently-announced BP Angola RLWI contract (following a well-timed FY16 acquisition of Blue Ocean – commentary within), and 2) affirmation of prior FTI (NC) guidance. On a relative (subsea) basis, we like OII vs. DRQ.
After a handful of disappointing OFS prints and (somewhat tone deaf) mgmt commentary elsewhere in the sector, NOV capped off the week with an otherwise solid combination of 1) a 4Q19 EBITDA beat, 2) surprisingly robust FCF, 3) proactive debt paydown, and 4) very (self-aware) mgmt color on further cost-out, balance sheet pragmatism, and shareholder friendly capital allocation (buybacks). Although 1Q20/out year numbers *may* not move all that much, given the perceived pull-forward in certain segments (akin to last year - link), NOV seems very much in tune with the “capital starvation” aspects of the current cycle, and (perhaps more importantly) is aligned with shareholders on what the market wants out of OFS equities. The recent pullback in oil does little to earnings estimates in our model, as further cost-out should offset incrementally lower topline growth, while net working capital cash contribution in FY20 drives $100 million more FCF vs. FY19 (+20% Y/Y).
Weekly OFS thoughts, including HP/PTEN/LBRT/NOV earnings and recap of DataVan frac activity in FY19.
Our Take – Flexing more cost-out muscle, FCF strong, debt paydown robust (albeit with a large one-time item). NOV reported 4Q19 earnings AMC today and is hosting a call tmrw (02/07) at 11am ET. NOV posted a solid 8% rev beat of WR/cons in 4Q19, and continued cost-out (almost entirely in SG&A) drove $288M in adjusted EBITDA (a 27% beat vs. cons, excluding a $537M impairment & restructuring charge). Regardless of the 1Q20 guide on tomorrow’s call (whether 4Q19 was a “pull-forward” quarter) NOV executed a substantial FCF beat (~$400M vs. ~$200M cons, exceeding prior FCF guidance on both WC mgmt & lower-than-expected capex) and paid down nearly $500M in debt (presumably the $1.4B in notes due Dec 2022). It is clear that NOV is taking its right-size approach to both ops and the balance sheet, which should be rewarded in the current paradigm. Leverage target could be a focus on the call, especially in the context of increased shareholder returns.
The drilling segment drove the 4Q19 miss, with cost creep on higher-than-expected rig churn/basin movement. If current oil prices hold, PTEN should see a more stable L48 rig count yield to better cost control, although a broader influx of rig capacity into the Permian (and continued high-grading of the USL fleet to super spec) could continue to pressure rig margins in a flat dayrate environment. Where the drilling result was frustrating, the strategy to continue operating 10 frac spreads at current profitability levels is perhaps the tougher pill to swallow for investors. To be clear, we still firmly believe (even despite the demoralizing PTEN/LBRT prints), that the USL market will reach a healthier balance toward the middle of FY20. However, for a PTEN frac segment that peaked at $15M ann EBITDA/spread in 1Q18 (not including capitalized fluid ends, and vs. $27M/spread for LBRT), it is tougher to understand why the company will continue to run 10 spreads in the near-term. Where peers (inc LBRT) will likely see a ‘snap back’ in utilization and fleet profitability, PTEN noted a ‘major oil company’ shut down as part of another disappointing 1Q20 frac setup.
To play offense in a contracting US frac market is certainly a strategic differentiator of LBRT vs. peers, and the pitfalls of the market share strategy were evident in disappointing 4Q19 results. On the whole, FY19 was a decent year for LBRT (vs. peers), and a utilization ‘bounce back’ in 1Q20 should yield favorable cost absorption and EBITDA/fleet improvement from the annualized, 4Q low of $5.2M/fleet (worst level since 4Q16) toward a FY20 avg of $10M/fleet. Despite a potential ‘bounce back’, the sobering 4Q19 print and resulting structural concerns drove the stock down 13%, its worst ever post-EPS stock performance. One concern is whether recent share gains will be defensible in a ‘flatter’ USL growth environment (and what profitability will look like), and the second (tied to the first) is whether continued, against-the-grain newbuilding is the best use of cash. We are sticking with LBRT OP, and are unwavering in our WR Pumping ‘top pick’ designation because we believe that 1) supply-side attrition is real (i.e. one doesn’t have to believe in dedicated E&P alignment), and 2) ESG pressures will see LBRT’s leadership in the realm of Dual Fuel bear fruit.
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