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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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).
The near-term outlook is remarkably clear for BHGE’s OFS segment – NAM friction will be minimal given lack of pumping exposure, while there is still plenty of int’l runway (beyond a burgeoning, multi-year organic growth cycle) to continue to take share and drive outsized margin expansion. TPS is on track to accelerate through YE19 into a prolonged liquefaction buildout (link), and OFE margins continue to grind higher (despite some lumpiness). Working capital execution is already excellent, but the company expects continued improvement and we see appreciable FCF growth in FY20. The most difficult task, then, is to comp/value BHGE relative to primary peers based on its differentiated exposure outside of traditional oilfield services. On the NTM EBITDA front, we are comfortable with the 10x FY2020 EBITDA driving our YE19 PT of $34 (a premium to HAL 9.5x) given the duality of OFS share growth in both int’l and NAM. On the FCF yield front we’re comfortable with the 3.5% FY20 yield (a premium to SLB 4.5%) given the nascence of the OFE/TPS-LNG cycles. Valuation premia isn’t based on “late cycle”, it is rooted in “different cycle” for BHGE’s unique, non-oil exposures. We maintain BHGE Outperform with YE19 PT of $34 (up from $33).
BHGE’s 2Q earnings beat resembles a “best hits album” of SLB/HAL/NOV earnings – The company 1) continued to beat on OFS topline growth and margins (like HAL), 2) posted solid FCF generation (like SLB), and 3) saw strong order intake (like NOV, although driven more by TPS and DS than lumpy subsea/OFE). In OFS, the company continues to benefit from ample share gain runway and lower base for pricing/margin improvement. OFE was perhaps the lone sore spot, although positive margin momentum offset softer sales, while a strong TPS result (and +32% YoY order growth) was driven by an acceleration of LNG-related activity in the quarter. In addition to segment-specific guidance, we will be looking for additional color on capex and working capital (DSO/DSI execution was solid) as it relates to near-term FCF potential.
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.
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.
Our Take – Curious stock reaction to an otherwise solid quarter, but the road to recovery is long (in an unloved sector, burden of proof is high). We were contemplating a much more positive stock reaction compared to the one that SPN got for an otherwise positive 2Q result and constructive call commentary. The short cover rally earlier in the week perhaps dulled today’s positive surprise, or perhaps quant sell pressure (see QES Malessa ranking within) and self-fulfilling market cap constraints are keeping fundamental investors on the sidelines. In lieu of any great grasp on the intraday idiosyncrasies plaguing the stock, we see the combination of 2Q results, upside to the 2H19 FCF guide, and evidence of a healthier-than-expected OFS divestiture market as all fundamentally positive for balance sheet survivorship. We maintain SPN Outperform and YE19 PT of $3, based on 5x our 2020 EBITDA of $311 million (down from $317 million).
So far, investor feedback from what we viewed as constructive SLB/HAL earnings commentary has been decidedly split between 1) those encouraged by the capital discipline as a “bridge” to refreshed FY20 NAM budgets, and 2) those dubious that the bottom is in for pricing/margins (or that cost takeout will not offset a weakening NAM outlook). We came out in our preview (link) citing stronger-than-expected FCF as the key 2Q19 catalyst/theme (either in print or 2H19 guide), and so far both SLB (link) and HAL (link) have leveraged continued capex cuts to drive (modest) incremental positivity back into the sector. Beyond cost/capital allocation, clearly generalist investors need to see evidence of sustained earnings power improvement, which we believe will follow SLB/HAL discipline as equipment cannibalization/scrapping accelerates and the E&P spending mix shifts to higher-quality int’l/offshore activity. So far so good through early 2Q earnings – clearly OFS is ready to mirror E&P discipline – but earnings power follow-through is still difficult to discern given lack of upward revisions.
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