This morning (7/22/19), HAL posted 2Q19 EPS of $0.35/sh (vs. $0.30 cons), adjusted for $247M in severance/impairment costs ($0.26/sh). Cost control drove a 7% EBIT beat (particularly in C&P), with total revenue of $5.9B largely in-line with consensus. FCF of $43M underwhelmed street expectations, but as noted in our OFS preview, fears of an FCF neutral quarter (or worse) had largely been captured in recent underperformance. Longer-term, we see this as an encouraging result given the strong, 64% incremental EBIT margins as evidence of robust cost takeout – particularly for C&P (71% inc EBIT margins QoQ) as NAM heads into a softer 2H19 for frac. Similar to SLB last week, a potential 2H19 FCF guide represents a key, intraday catalyst. Overall, we see cost takeout as the key, positive surprise given market focus on pricing/margin friction in the context of go-forward earnings power for the sector.
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Our Take – Positive 2H FCF outlook, more strategic details to come in the capital-light Era of Olivier. SLB hit 2Q estimates and noted that prior 3Q consensus of $0.42 is achievable (albeit with minimal upside) which helps stabilize out year estimates. Lack of visibility into 2H19 NAM activity will likely be a pervasive earnings theme across OFS, but as we noted in our earnings preview, the FCF outlook is now core to investor reaction – in our view, a positive 2H19 FCF guide of $2.4B+ drove the intra-day rally in the SLB shares. On the print/call however, three potential market pushback points that could be focal to the N-T SLB narrative include 1) underwhelming Drilling margins, underpinned by USL and IDS execution, 2) uncertainty surrounding incremental “SPM-light” projects, and 3) ambiguity around the OneStim strategy, particularly in the context of Mark Papa’s appointment as Chairman. We received all three in investor feedback, but see concerns as overblown.
SLB hit 2Q estimates and noted that prior 3Q consensus of $0.42 is achievable (albeit with minimal upside) which helps stabilize out year estimates. Lack of visibility into 2H19 NAM activity will likely be a pervasive earnings theme across OFS, but as we noted in our earnings preview, the FCF outlook is now core to investor reaction – in our view, a positive 2H19 FCF guide of $2.4B+ drove the intra-day rally in the SLB shares. On the print/call however, three potential market pushback points that could be focal to the N-T SLB narrative include 1) underwhelming Drilling margins, underpinned by USL and IDS execution, 2) uncertainty surrounding incremental “SPM-light” projects, and 3) ambiguity around the OneStim strategy, particularly in the context of Mark Papa’s appointment as Chairman. We received all three in investor feedback, but see concerns as overblown.
A slight rev beat (+5% vs WR +2%) and lower incremental margins (24% vs. WR 39%) drove a “no surprises” quarter. Int’l acceleration led the topline beat, but NAM/Production revenue also saw solid, single digit QoQ growth. Prod/Cameron beats offset Drilling weakness, which makes sense in the context of the L48 rig count bleed and overall USL shift to completions. Capex came in a bit hot, and FCF slightly lower than consensus, but SLB reiterated its prior FY19 capex guide (and we still see downside). Olivier Le Peuch, previously tapped as Paal Kibsgaard successor as CEO, was officially named CEO effective Aug 1, while Mark Papa (a founding father of US shale) was named the BoD Chairman (as Paal will retire).
To kick off what we viewed to be a make-or-break year for US shale & OFS (mostly break for the equities of late, but OFS is flat YTD – score reset), we published our first US Productivity Report (link). In the report, we postulated that a lower E&P spending cadence, combined with productivity frictions across key shale basins, would yield underwhelming US supply growth (and likely alter the market perception of shale growth over the coming years). Since then, demand considerations (Margolin link) and US-China (& US-Iran) tweets have dominated the oil tape, but US supply is still a crucial piece of the crude puzzle, and we think it important to revisit this (mainly in pictures/charts) ahead of SLB’s commentary tomorrow morning (7/19/19).
Late last week, we published a 2Q OFS earnings preview (link) that was perhaps a bit more optimistic than recent OFS performance would reflect in the broader energy market. Our thesis is simple – with recent underperformance having captured the impending negative revision across the sector, another down-cut to OFS capex (particularly in frac) could drive stronger-than-expected FCF through the balance of FY19. Nearly every company that we caught up with alluded to further capex reductions in response to E&P budget exhaustion. With OFS growth/reactivation capex having already been deployed through FY17/18 (e-frac overhaul notwithstanding – although we see slower adoption) ) the evolution of a lower-growth E&P spending paradigm over the coming years could portend a more stable & sustainable FCF environment for NAM OFS.
In light of particularly morose investor meetings in recent weeks, perhaps the OFS sector should call out a Weatherford fishing hand to retrieve buyside sentiment. In our view, an impending negative revision to 2H19 NAM estimates is largely priced into an OFS sector that has underperformed the XLE by 400bps YTD (and the commodity even more substantially). With the expectation that US E&P spending growth will moderate over the next 3-5 years, and that oil prices will remain range bound, OFS FCF will become increasingly scrutinized in the context of appreciably lower earnings power (compared to prior cycles). Into 2Q earnings, we see further capex reductions and upside to FCF as a powerful positive catalyst against an otherwise negative macro backdrop for OFS.
The key OFS takeaway from Monday’s Wolfe Energy quarterly lunch was that USL volume beats (due to peak March completions) and a well-timed wind-down of 2Q E&P capex would be a tough look for OFS earnings vs. supply-side macro. The expectation that 2H19 OFS estimates need to come down is already reflected in the recent OFS UP, in our view, and we believe that the market may be underappreciating further OFS capex reductions associated with softening activity through the back half of FY19. Within, we refresh the capex outlook for our coverage – Front end loaded OFS spending, combined with WC friction (related to collections from tight E&P budgets) may not bode well for 2Q earnings themselves, but back half capex reductions that offset downward consensus revisions (already priced in) could yield key upside catalysts for those OFS companies with decent-enough visibility to provide FCF guidance. We have a few names in mind following recent catch ups.
Wishing our clients/corporate compatriots a happy & safe July 4th – if we had to pick a song that embodies both the holiday and the embattled, but unyielding spirit of the OFS sector – Johnny Cash Ragged old Flag. With 2Q earnings looming and sentiment dragging along an unquantifiable bottom, the key question into 2H19 is whether the upstream spending mix shift, from USL to int’l, can help our global coverage partially break away from the hypercyclical whims of US E&Ps. A contrarian bull case – with adequate OFS growth/reactivation capital having been steadily deployed from 2H16-1H19, a lower “sustaining” shale activity trajectory could yield appreciable upside to USL FCF (primarily for SLB, HAL, and other geographically-diversified SMID cap service names). WR Drilling is poised for robust FCF generation (dayrate stability would likely OP expectations), while WR Pumping has identified the pitfalls of rapid e-frac adoption. Capital allocation will continue to dominate the OFS narrative, and 2H19 conservatism might do more to insulate OFS from USL spending trends than would upside to int’l/offshore activity.
This am (6/28/19), PUMP announced an amended DuraStim purchase agreement with AFGlobal. The net impact to PUMP was that it replaced-A) the prior purchase agreement for six (6) DuraStim fleets with-B) an agreement to acquire three (3) DuraStim fleets & an option to purchase three (3) additional spreads through FY20. While we remain positive on PUMP’s first mover advantage in adopting DuraStim, we recognize that the market may react poorly – incremental cash outlay, and also because the market was unaware of the previous six-spread purchase agreement. Buy a potential dip.
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