Mid-day Rumblings following our quarterly Crew Change & Upstream Activity Update. On the activity front, we lowered our capex, drilling and pumping estimates in NAM, with capex/drilling sharpened around high single-digit int’l growth in FY19/FY20. The next activity bogey will be when E&Ps provide guidance for FY20 (which we will likely use as a ‘steadier-state’ proxy for growth over the coming 3-5 years). Key takes from the recap 1) FCF: Although 2Q underwhelmed, the FCF thesis is playing out with OFS (in aggregate) cutting growth, 2) Pricing: OFS controls its own destiny wrt FY20 FCF via pricing discipline (perhaps more autonomy than other parts of the energy value chain that are more beholden to commodity volume/pricing), and 3) Int’l: Cycle will continue to be a key stabilizing force to ests. We also installed a FCF yield framework, whereby our revised top picks HAL, PTEN, TS, and LBRT (conditionally, PUMP) screen very favorably.
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We are updating our Capex, Drilling, Pumping, and Production models, in tandem with our 2Q19 Quarterly Crew Change (OFS earnings recap)
Within, we are lowering NTM EV/EBITDA multiples and YE19 price targets across our coverage, in addition to upgrading Tenaris (TS) to Outperform (from PP)
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.
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.