YTD, our ‘NAM bucket’ of OFS stocks are down ~60%, where the ‘survivor’ counterparts (SLB, TS, NESR, BKR, among others) are only down ~50%. Since the mid-Mar sector bottom however, the NAM-centric names have outperformed, despite the fact that fundamentals shouldn’t materially improve as long as WTI remains below $50. Entering the year, consensus saw a 10-15% Y/Y decline in NAM spending/activity, whereas now the bogey is a 50-60%+ contraction. We think the market is pricing in too much of a ‘V-shaped’ recovery in NAM activity & earnings, and in fact see rig/crew adds at $35+ WTI as detrimental to OFS cash burn. Perhaps symptomatic of the broader market small cap/beta rally, the NAM vs. ‘survivor’ trade (in our view) is a rare opportunity in which a potential N-T unwind aligns with the longer-term call for better global upstream balance & earnings power recapture for the ‘survivors’ (as US shale becomes a smaller portion of the growth in the next expansionary cycle). While we count HAL in the ‘survivor’ bucket, this performance trend is especially evident in the recent ‘flippening’ of the SLB-HAL EV/EBITDA multiple spread. Traditional valuation metrics have deteriorated, but within we show recent NAM vs. ‘survivor’ performance & EBITDA multiple trends, highlighting that unwind of the trade since mid-Mar (either through ‘survivor’ catch-up, or NAM cool-off) dovetails with our call that structural contraction in US shale is positive for the longer-term outlook of more globally-diversified names.
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Wanted to flag this BBG story (link), in which DO (NC) was cited as recouping a $9.7M CARES tax benefit to pay out executives through bankruptcy. Of course, taking this story simplistically at face value may betray the possibility that the cash benefit could have accrued completely to creditors through restructuring (rather than supporting business continuity and employment), but it is a tough look. What OFS mgmt teams say and do in navigating this downturn, including executive comp reduction and allocation of any government aid, has a greater-than-expected (morale) impact on field crews, which in turn is a service quality differentiator (take a look at what MGY said regarding crew quality).
Weekly OFS thoughts, including takeaways from CLB mgmt meetings, E&P earnings activity read-throughs, and the OII 1Q20 print.
Getting aggressive on cost cuts as focus shifts to downturn duration, FCF & the ’24 notes. The deepwater drilling market had just turned the corner in FY19, prior to what has been a disastrous 2020 for OFS. Fortunately, OII had been padding its balance sheet with cash in conjunction with the prior offshore expansion. Decisive cost reductions carried 1Q20, and should be supportive of positive FCF through the balance of FY20. In our view however, FY21 looks a bit more challenged from a cash flow perspective, in lieu of a market recovery and lack of WC unwind. Maintain PP, raise YE20 PT to $4 (from $3), based on 10x our FY21 EBITDA of $90M (from $103M).
OII reported 1Q20 earnings AMC yday, and is hosting a call today (5/14) at 11am ET. The company posted a modest topline beat, and solid EBIT beats across nearly all reporting segments as deeper-than-expected cost cuts were realized. While 2Q/full year 2020 guidance was withdrawn, the company established a N-T cost-out target of $125-160M annualized (650-700bps on FY19 revenue) by YE20 (inclusive of $35-40M of lower depreciation, partially tied to the $379M impairment taken in 1Q20). To-date, OII has achieved $70M of the cost benefit, and cited further cash tax declines and a ~20% Y/Y decrease in FY20 capex as additional balance sheet tailwinds. In sum, the company expects to generate positive FCF in FY20, with the nearest & major debt maturity of $500M notes due Nov ’24 (trading at 62). We do need more color on revolver covenant relief, given what we perceive to be a challenged 55% capitalization ratio (on the back of 1Q20 write downs).
1Q20 E&P earnings have corroborated the grim 2Q/2H20 outlook for OFS. Activity and pricing are forging new lows as upstream capex is cut in half or worse. Within we tabulate update budget guidance for the largest E&Ps, present respective rig count and frac spread guides, and present a list of choice quotes from each call. Acceptance is the first step to recovery
Last week, we hosted CLB CEO (to be) Larry Bruno, CFO Chris Hill, and SVP of Corp Dev/IR Gwen Schreffler in investor meetings and a fireside chat, in which the company addressed both key N-T concerns (balance sheet) and L-T questions (structural risks) related to a ’rebuilding thesis’ still in its nascent stages. With US shale contracting and a global upstream rebalance potentially in-play on the back end of the current downturn, we see any (potential) mix-shift back toward int’l & offshore (conventional) activity as restorative to OFS earnings power broadly. For CLB, specifically, our ‘rebuilding thesis’ is predicated on 1) CLB navigating N-T balance sheet (covenant) risk, and 2) sustained competitive adv in RD, which would manifest in appreciable L-T earnings recapture assuming the global upstream mix-shift away from US shale plays out like we envision.
A debate is (and should be) brewing over the future of US shale – Is global upstream rebalancing a reality? We put out a note last week (see below) that basically captures the crux of survivorship for the OFS sector. After this downturn, is the ‘returns vs. growth’ mantra going to 1) keep a lid on US shale growth and 2) incentivize more balanced (global) upstream investment based more so on breakeven economics (vs. cycle time)? Or, will E&Ps get back to growth sub-$50 oil (like has been suggested by prominent E&Ps, and perhaps an IOC)? Global rebalancing would be restorative to earnings power, and SLB, TS & NESR are our top ways to play, but BKR, NOV & CLB also fall in line with the theme. Wait and see on HAL & APY given the NAM exposure.
Weekly OFS thoughts, including global upstream rebalancing, TS/NESR prints, and model updates (NBR, DRQ, RES).
1Q20 OFS earnings have largely wrapped up to this point, and the 2Q pain is fairly well understood (zero 2H20 visibility). Earlier this week, we posited that significant USL contraction would give way to more balanced global upstream spending out of the current downturn, but E&P commentary this week tells a different (and more discouraging tale). At current oil prices, US supply will fall appreciably (up to 20% of Permian production shut-in, how much could be impaired?), but E&Ps are now saying that steady DUC drawdown would occur above $30 WTI. Above $35 WTI, prominent E&Ps are signaling volume growth. The OFS capacity is there, and as always it is incumbent on our companies to push back on a shrinking US shale cost structure. OFS discipline has been elusive, and we doubt that the exodus of labor will be much of a bottleneck to activity growth (not many opportunities in the COVID paradigm).