Solid execution from SLB in its first quarter under CEO Le Peuch (appointed in July), especially in the face of heightened NAM headwinds and market pessimism toward OFS/oil. Adjusted 3Q EPS of $0.43/sh handily beat WR/cons of $0.40. Marginal revenue growth in NAM was a positive surprise vs. US frac and rig count weakness (buoyed by GoM), but the bulk of the beat was driven by int’l (seasonal Northern Hemi activity and exceedingly strong incrementals in Reservoir Characterization). SLB limited capex, managed WC well, and drove solid FCF in excess of our est. The $12.7B write down was mostly non-cash (intangibles), although the $1.6B frac write down is indicative of the accelerated pivot toward a more capital-light NAM footprint.
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CHOW – PE/JAG from the OFS perspective – Will E&P consolidation further squeeze service pricing in a lower growth USL environment? Within, we take a look at the rig/frac exposure at play in this week’s PE/JAG tie up, the conclusion being that legacy OFS suppliers for PE are likely to benefit at the expense of those working for JAG (understandably). However, given that PE takes a “squeeze the turnip” approach to service pricing and capital efficiency, we also believe that broader consolidation trends across E&P could further (and permanently) undermine the pricing power of a much more fragmented OFS contingent. While pumpers cite unsustainably low pricing, E&Ps purport continued unit cost tailwinds into FY20, a dislocation in messaging that could inevitably see bad OFS actors acquiesce to larger, post-merger operators in the Permian (unless the frac subsector also consolidates, in the face of low barriers-to-entry). We also observe a HAL/LPI case study which tells of a more amicable equilibrium between OFS, E&P, efficiency and more sustainable investment growth.
From an oil supply side standpoint, the only catalyst that matters is US shale. The LO/generalist market has largely given up on OFS, right before what we believe will be the most impactful structural shift in oil S/D in the past decade – one that benefits OFS, as it stimulates higher calorie int’l/offshore activity and serves as a bbl/$ tailwind for USL drillers and frac. 3Q OFS earnings will be dominated by SLB/HAL/BHGE on the E-Hemi, but equity markets will be looking to the Permian for early indication of the new normal for a ‘steadier state’ US shale complex.
CHOW – Div yields looking increasingly attractive. Where should OFS trade? As the OFS sellside collective (including us) prepares another round of earnings preview, we revisit our 2Q Preview in the context of rising div/FCF yields across OFS. We continue to see more consensus FCF stability vs. associated earnings revisions. With 1) clarity on FY20 NAM spending, 2) demonstrated margin stability despite a contracting NAM environment (aided by int’l tailwinds), and 3) further capex reductions in a broader shift to ‘capital-light’, we believe the S&P500 div yield bogey is tenable for an OFS sector that is both A) at subdued EPS power, and B) overly discounted in terms of near-term growth (or perceived lack thereof). Upside across coverage.
The Wolfe Utilities & Energy conference hosted several thematic, multi-sector panels, including US L48 productivity trends and the EV impact on long-term oil demand. The high-level conclusion is that the current oil supply setup is arguably the most bullish since 2011, while the demand framework is the most bearish in that same timespan. Our house view is that negative near-term demand trends could be beaten back by the lower supply picture, presenting a constructive oil macro set up. However, poor sector sentiment is unlikely to reverse in the near term with a soft global economic data stream.
E&P budget exhaustion is already being felt within the super spec USL rig market and across an embattled pumping subsector. E&P alignment is crucial, and tracking rig/frac activity into 3Q earnings (in addition to capturing E&P budget exhaustion impact on 4Q) will be crucial in navigating an otherwise sloppy 2H19 for NAM OFS. Yesterday, we published the September Data Van Download, which provides ests for QTD frac volumes and E&P alignment for key frac players. Complementing this frac monthly, we also recently rolled out our Cat Walk Chronicle, which provides a similar, layer-deeper look at the domestic drilling/super spec rig market.
June appears to be the localized peak for 2019 activity following a strong March/April YTD high, as July and August frac totals indicate a modest falloff from first half activity. Recent feedback from pumpers confirms that E&P budget exhaustion has already begun to negatively impact the rate of activity, given a combination of early rollovers and increased white space for those dedicated crews that will likely see lumpier utilization through year end. E&Ps appear to be rotating capex dollars out of drilling programs (given the rig count decline and a more uniform draw down of DUC inventories across every major shale basin), and barring another round of OFS pricing concessions will either 1) introduce more calendar white space to maintain favored fac crews, or 2) cut rig crews as budget exhaustion hits. For a supply-side view of how this tracker data will impact the broader oil macro (positively), see Wolfe Energy’s recent oil note.
Red vs. Blue: A Tactical Twist On Our HAL/SLB Recommendation. Last Friday (09/20/19) we published a detailed case for why we thought SLB was better positioned than HAL into 3Q earnings but doubled down on our LT preference for HAL over SLB. We think SLB’s regime change and nascent strategy provide a better risk-reward profile into the 3Q print relative to HAL, with the latter more exposed to weakening pumping sentiment (a misconceived narrative we don’t envision shifting NT). Client feedback on both perspectives has emboldened our conviction on both sides of the call.
The past five years have been terrible for OFS and exceptionally painful for investors that have been persistently long the sector. The macro backdrop for OFS has become increasingly tenuous, such that more factors need to cooperate to sustain a modest upcycle. Whereas E&Ps previously would reliably outspend budgets by +20%, they are now more inclined to abruptly stopping work programs prior to year-end. In the current paradigm, we acknowledge that minor differences in macro views or time horizons can nullify broader stock calls, and are conscientious that a rising proportion of OFS observers are now market neutral. With this in mind, we are introducing a periodical tailored towards shorter timeframes and more actionable calls that may not necessarily mesh with our longer-term theses. In this report, we detail our thoughts for why we believe SLB is primed to outperform HAL into 3Q earnings, and also rehash our thesis for why we prefer HAL to SLB longer-term.
Yesterday’s (09/17/19) messaging from officials close to the supply disruption in Saudi would suggest a more expedited resolution than had previously been captured in the energy market “spike” earlier in the week. Wolfe Energy team reaction contemplated the go-forward risk premium that should be captured in crude prices, and it appears that oil has settled about $3-4/bbl higher than it was before the disruption – Sam Margolin further noted that heightened US exports could keep the Brent-WTI diff in check, and we are curious to see how a potential spot-shift in supply could impact US inventories. Trading-wise, oil beta OFS/E&P names generally outperformed in an otherwise volatile two days of trading, and higher short interest (specifically) saw the biggest bid. The key take from the OFS perspective (color from Silverstein’s E&P Armageddon webcast) is that upstream operations were minimally disrupted in country (and all employees safe and accounted for), but we see logistical/administrative frictions during & following the outage as potentially negative for both project start-ups (as previously called out by HAL, and following a particularly slow August month) and also collections/AR in 3Q.
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