While nascent, 4Q19 OFS earnings have yielded additional clarity on a USL market that should benefit from ‘real’ frac attrition and the ongoing SLB pivot. HAL, above all, should realize earnings upside from a ‘steadier state’ E&P spending cadence and more balanced OFS supply. If HAL can continue to outpace on the int’l front (leveraging a more competitive D&E portfolio and mix tailwinds for C&P) we see better EPS power upside and a lower capex threshold as supportive of sustainably higher FCF moving forward. If anything (besides the oil tape), pessimism came from the 1Q20 guide vs. a solid 4Q19 result, although this was to be expected seasonally (and didn't impact prior street EPS).
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This am (1/21/20), HAL posted 4Q19 EPS of $0.32/sh (beat WR/cons $0.29/sh, excluding a $2.2B impairment), with another round of NAM cost takeout fueling another strong C&P margin beat (flat QoQ margins despite the 13% sequential topline decline). HAL Revenue of $5,191 million beat WR/cons by 2% and was down 6% sequentially, while EBIT of $546 million improved 2% QoQ (9% better than WR/cons). NAM revenue fell 21% QoQ (vs. SLB -14%, -18 ex-GoM) while int’l topline grew 10% sequentially (vs. SLB +2%), with HAL (+10% YoY) having outpaced SLB (+7% YoY) on int’l growth in FY19. While D&E underwhelmed on margins (75bps short of WR/cons, and a key focus as it relates to the 1Q20 guide), both NAM C&P and int’l share gains are key fundamental positives. FCF missed WR/cons modestly (mostly on severance/deferred tax), but further rightsizing of the NAM C&P footprint could see FY20 capex ests come down materially YoY.
The print was solid (outside of Cameron margins), with the shift to ‘asset light’ (and global mix-shift toward int’l) yielding solid margin improvement across ResChar, Drilling & Production. FCF execution was robust on collections. The call focused around the ongoing NAM portfolio strategy, and as anticipated, the company gave quantitative detail around the state of OneStim (frac). Moving forward, SLB will cap marketed HHP at 50% of nameplate (we est. ~2M total, ~1M marketed), with a 30% reduction in net active fleets vs. 3Q (we est ~400k HHP). The company also plans to exit USL coil and rod lift. In the end, we are better able to quantify the revenue ‘carve out’ as a result of the moving pieces in NAM, while SLB pegs a 2H20 offshore (exploration) inflection as the next leg up for earnings power. While we like SLB’s internal aim at improving earnings power/stability, and FCF/sh generation, we remain cautious as the exit from USL (and discipline in E-Hemi) may accrue more to peers.
Weekly OFS thoughts, including SLB 4Q19 earnings and Houston meetings from last week
Better-than-expected margins (ex-CAM) and notable receivables capture drove solid FCF execution, despite the many moving operational pieces of the fit-for-basin rollout (particularly in NAM). NAM topline fell by 14% QoQ, the decline led by USL -19% (OneStim -33%), while int’l grew 2% sequentially and ended FY19 on-target with the prior high single-digit growth bogey. The market should appreciate the FCF execution, as SLB leads the OFS charge toward higher margins, earnings power, and shareholder returns (in a maturing upstream growth environment). However, the expectation that SLB would ‘quantify’ its shrinking of the US pumping business was perhaps muddled by press release commentary of “stacking”, “right-sizing”, and “scale-to-fit” directives (hopefully more color on the call). SLB recognized nearly $400M of NAM/other restructuring & workforce charges, and alluded to additional ‘exiting of UP NAM business units’ in FY20.
With full 4Q19 RigData in the books, the fleeting weeks of FY19 saw somewhat of a stabilization in the L48 rig count, with continued ‘high grading’ helping to buoy super spec utilization and pricing into YE. The WR Land Drilling trackers remain mixed as the sector heads into a pivotal earnings season (for E&P budgeting). HP is tracking largely in-line, with a late uptick in rig demand likely driven by MidCon. NBR is tracking lower than its implied guide, with a perceived rollover with XOM partially offset by pickups for EOG. PTEN is tracking lower vs. its guide, although the Nov rig count was +3 m/m and improved modestly into mid-Jan. Finally, PD-CA is tracking in-line with its prior guide, its Permian weighting (and appreciable IOC alignment) helping to stabilize activity. Like last month, we remain relatively cautious on drilling vs. frac, with ‘flat’ rig pricing and super spec high grading potentially yielding margin compression.
This week in Houston, we met with several E&Ps and over 1/3rd of our coverage (see takes on OII, NBR, DRQ, PD-CA, WHD, SPN, TS & APY) after catching up with others last week. From a sentiment perspective, the aggregate tone of the meetings was probably better than we had expected going in, understanding that 'budget reload' this year wouldn't necessarily yield a snap-back in activity in USL. For shale-centric OFS, the key question is whether the industry can "smooth out" the normalized D&C cadence and mitigate the wild, wasteful activity swings that would call for the continuous staffing/culling of a shrinking supply base (visibility could go a long way for both OFS and E&P). For int'l/offshore OFS, there is heightened positivity around the GoM (specifically) and int'l mix (broadly) in FY20. TS takes were particularly enlightening. Conclusion – We don't foresee a "this is this year!" explosion in EPS power & ests (the market has become numb to years of these repeated calls), but global mix is improving, OFS S/D is trending towards a *stickier* balance, and our companies are almost uniformly aligned with the call for FCF & shareholder returns (dare we say that ROIC matters much less in the current paradigm).
SLB kicks off energy earnings this Friday (1/17), and HAL will offer its rebuttal the following Tuesday (1/20). Both stocks have performed well since SLB's 3Q19 earnings announcement on 10/18, with HAL (+28%) having modestly outpaced SLB (+23%). We believe this unwind from the previously-consensus SLB over HAL trade is attributable to HAL's strong (and seemingly unwavering) 4Q margin guide, bolstered by continued, aggressive cost cutting in L48 frac (so perhaps more a C&P margin beat than D&E driven...with 1Q20 a BIG wildcard in D&E). Of course HAL vs. SLB remains a zero sum game globally, but both companies could engender incremental OFS optimism if 1) SLB's ongoing pivot away from certain L48 segments drives tangible margin improvement (as laid out in its Sep conference address), and 2) if this SLB discipline helps stabilize the NAM C&P margin outlook for HAL. Tactically, we still like HAL to sustain momentum vs. SLB through earnings (we still see more uncertainty around SLB's strategic pivot globally than around HAL's cost mangement in USL). Within, we revisit HAL vs. SLB trends in terms of margin spread and FCF conversion, both come into better parity through a FY19 period in which HAL's stock underperformed.
OFS is no stranger to equity underperformance against a firming commodity price, but multiple compression and rising FCF yields across the coverage through FY19 (up until the recent Nov/Dec rally) call into question whether select OFS equities (with strong balance sheets) are viable go-private vehicles. Inspired by a recent IPP LBO exercise from our colleagues (Steve Fleishman and the Wolfe Utilities team – link), and having fielded comments from both clients and management teams regarding alternate OFS investment avenues, we analyzed a handful hypothetical LBO’s within the services space (NESR, PUMP, LBRT, RES, WHD, HP, TS – too big). Despite the (requisite) conservatism baked into our valuation, earnings, and IRR assumptions, only NESR screens favorably as an LBO candidate at current stock levels. The recent 4Q rally largely disqualifies clean (low debt), USL drilling/frac in our purview, but suggests somewhat of a floor near 3Q19 levels.
Wolfe Energy published its Energy Gauge yday pm (01/07/20). The WR OFS Index improved 21% in Dec, a strong finish for the quarter (+25%) and FY19 (-5%). OFS has led all energy subsectors over the last three months, driven by a combination of 1) oil beta and 2) an ongoing activity shift from NAM (shale) to int’l/offshore markets, which is anticipated to enrich earnings power among global services providers in the coming year(s). Additionally, sentiment across HAL/pumping also improved on a perceived bottom for USL frac (a significant source of OFS UP mid-year). Within, we look at EV/EBITDA & FCF yield now vs. prior periods, and relative to the OFS valuation weathervane, SLB. The conclusion: while multiples remain compressed and yields expanded relative to prior periods, a more mature OFS sector needs to see a positive revision cycle for the rally to continue in 2020. Oil prices alone can’t drive the rerating higher.
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