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.
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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).
Yesterday (07/30/19) was one of the greener days for OFS in recent memory, with chatter suggesting that rotation (out of momentum?) into energy, and the subsequent short squeeze amplified an otherwise decent oil tape. For those companies that reported (NBR +30% & NOV +11% in our coverage) the moves were more pronounced. While neither NBR/NOV print signaled a drastic upward earnings inflection (although int’l momentum is helping to stabilize estimates) both companies followed the familiar 2Q OFS playbook of 1) caveating 2H19 friction in NAM, and 2) cutting capex (for NBR, a more pronounced FY20 capex cut in-line with peers). If it stands, the reported API crude draw last night could inject more life into an underperforming OFS subsector that is aligning costs/capex quickly with E&P.
NBR issued a relatively benign USL drilling guide (vs. peers) and illustrated a clear path to paying down its 2020 maturity. A favorable (IOC-heavy) customer mix will perhaps blunt the impact of a softening L48 rig count, which is likely to be felt more negatively by peers (HP/PTEN). Combined with what we argue is more defensible pricing base, NBR reiterated strong customer demand for super spec capacity and has received inquiries for rig contracts in 4Q19/1Q20. Continued resiliency within USL drilling lends itself to a more favorable int’l handoff, which remains core to our positive thesis but continues to see growth/margin friction due to various operational hurdles. Overall, a better-than-expected L48 outlook, visibility into much-anticipated int’l margin improvement, and a significant capex reduction in FY20 all coalesced on the 2Q print/call – a well-timed short squeeze also contributed to the rally.
NBR reported 2Q19 earnings AMC today and is hosting a call tmrw (7/30) at 11am ET. Not a bad print at first blush, especially in the context of last week’s souring of the WR Land Drilling narrative (with HP/PTEN taking down ests and no L48 rig count bottom in sight). NBR put up in-line revenue/EBITDA across its US Drilling, Drill Solutions, and Rig Tech segments, while Int’l/Canada results underwhelmed. Despite high capex, the company drove solid FCF of $82M (after div), reiterated FY19 capex at $400M, and affirmed its net debt reduction target of $200M+ on the back of EBITDA “improving over the following quarters”. While the print seems (relatively) benign compared to peers, we see continued int’l friction as a pain point – relative L48 strength will not be able to cover for int’l sluggishness, as FCF execution risk heightens in 2H19 (due to likely EBITDA cuts & implied 2H capex being marginally above “maintenance” level).
An acceleration of May/June filings in the Permian/Bakken suggests a steady grind higher from the March 1Q peak, while auxiliary basins (namely Anadarko & Northeast) remain lumpy. Nevertheless, 2Q turned out to be a modest growth quarter for USL frac activity. On the one hand, Rystad data squares with E&P commentary around a “pull forward” of 2H activity (in the context of YE budget exhaustion). On the other hand, the data update also overstates frac revenue growth for the handful of OFS companies that have reported (all else equal). Bottom line, if higher-than-expected Rystad frac growth is correct for 2Q, then L48 production should still see positive supply adjustments in lieu of counter-seasonal inventory builds. Also, OFS really needs to stop shedding price.
Similar to our take for HP, it seemed that the market (us included) were unprepared for the magnitude of the USL drilling guide down – and seemed to have placed more faith (than was deserved) in super spec pricing. Given its exposure to pressure pumping, the market remains slightly more skeptical of PTEN capex cuts in 2020, but we believe this unfairly captured in the PTEN discount vs. peers (and see more upside to FCF). We rate shares of PTEN Outperform with a YE19 price target of $14 (down from $16) based on 5.5x our 2020 EBITDA estimate of $694MM, as the multiple falls in-line with the average of the previous ’09-’14 cycle. PTEN screens cheap on an EV/Tier-1 Rig and EV/Tier1 & Upgradeable Rig basis compared to peers (see comp table within), although we recognize that a dual frac/drilling discount will persist in the current market.
Although we understood that there could be further pullback in the USL rig count, it appears the market (us included) was unprepared for the magnitude of estimate revisions. With HP expecting to drop 15 rigs in F4Q and margins under pressure, we’ve taken USL drilling estimates down with continued uncertainty around timing of the L48 rig count bottom. In the meantime, HP was strategic in focusing on what we anticipate to be a substantial cut to 2020 capex (the dividend appears safe), but upside to near-term cash flow remains minimal (relative to peers). We maintain HP Underperform with a YE19 PT of $44 (from $48) based on 6x our CY2020 EBITDA estimate of $822MM (from $907MM) as the multiple has an adequate dividend yield premium built-in, relative to both historicals and to peers.
HP reported F3Q19 earnings after market close yesterday (07/24/19) and is hosting a conference call to review results today (04/25) at 11am ET (10am CT).
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