To underscore the pessimism that has pervaded upstream energy is to beat a dead horse, but we wanted to flag yesterday’s 1Q20 Dallas Fed survey to juxtapose the commentary against the prior downturn. The fact that the wounds of ’15-’16 are relatively fresh is both the basis of more apocalyptic commentary (vs. 2015), and a driver of a more proactive OFS response. In recent days/weeks, we’ve asked the question “how much is left to cut across OFS?” (particularly in USL). While the near-term outlook remains opaque, we do believe that OFS (in aggregate through FY20/21) could outperform what may prove to be the more precipitous activity decline in FY15/16 (in terms of rev decline & incremental margins). Within, we compare responses now vs. those in the 1H15 KC Fed Surveys, to illustrate some interesting differences in the way both OFS and its customers are approaching the current downturn in US shale.
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This week, we caught up with another handful of mgmt/field contacts to get a real-time beat on the upstream fallout. Simply put, the fact that key, US-centric OFS withdrew guidance this late into the quarter underscores the sheer rate of degradation in activity, particularly juxtaposed against relatively upbeat Jan catchups & constructive messaging through (at least the early part of) earnings calls. Within, a summary chart tracking E&P budget cuts, and the drill/frac impact based on OFS/E&P alignment in FY19.
This COVID-19 & KSA price war driven collapse is a sinister combination of two overhangs, seemingly a combination of the ’08-’09 &’15-’16 downturns. Many oilfield families have been/will be impacted, and our thoughts go out to those in the industry.
The past week has been a confusing one for energy (and the broader market). This week, Sam Margolin updated the Wolfe oil deck & IOC ests/sensitivities following the recent crude collapse, and Josh Silverstein updated ests across his E&P coverage. Armed with a slightly better visibility into the producer capex response (with the bulk of E&Ps having slashed budgets/growth targets), we are also updating our beleaguered OFS coverage. We are lowering estimates & YE20 price targets, and changing ratings in response the swift O&G deterioration.
Lot of head scratching around Saudi’s decision to engage Russia in the price war, and clearly no one person has all the right answers on the geopolitics at play. From conversations with investors over the past several days, it stands to reason that Russia will be solid in the face of KSA OSPs and raised production. Saudi, and the GCC broadly, are the bigger question mark given that most countries don’t fiscally break even at current crude levels, and civil unrest is a potential theme. For OFS, the upside risk from here is 1) Coronavirus begins to dissipate (new cases decelerate) over the summer, and 2) KSA/Russia (perhaps supported by other GCC members) return to the table. SLB is the play on heightened Russia/KSA output (NESR also a winner in KSA), while BKR is the relative nat gas vs. oil play. Not much in NAM will work unless #1 and #2 are achieved above. TS (which quietly overtook HAL in terms of mkt cap) is globally diversified with decent BS/yield.
While COVID-19 could’ve been a “slow bleed” for US shale, Saudi perhaps delivered an expedited knock-out punch. Last week’s failed OPEC+ meetings devolved into an all-out Saudi oil price war on Saturday (3/7/20), which likely means that the coming days, weeks and months will see headlines purporting the imminent demise of the US ‘Shale Revolution’, in addition to that of many shale-centric energy equities unless a favorable KSA-Russia agreement can be reached. The OFS sector will be caught firmly in the fallout as crude prices test FY16 lows (WTI sub-$30, down 30% at the time of writing), and it is possible that there will be no relative ‘safe haven’ as the market 1) quantifies the oil price impact on E&P spending & FCF, 2) toggles upstream activity assumptions, and 3) disaggregates dividend coverage & insolvency risk (among other inputs) from the likely unprecedented collapse in OFS valuation (perhaps to meaningless levels if expected earnings evaporate with oil prices).
After falling 21.3% in January, our E&P Index fell by 19.9% in February with every producer finishing in negative territory. It’s been another volatile start to March, but if there is good news, it’s the opportunity to be more aggressive on several high-quality stocks at low multiples. COP, FANG, and PE trade <4.5x 2021 EBITDA at $50/bbl WTI, while CXO, EOG, and PXD trade <5.5x, providing value without having to go down the quality chain.
We caught up with a sales contact at a large, diversified OFS company covering customers in the Permian/EF/MidCon region, and as would be expected in this virus-driven commodity tape, our contact noted that several “large, prominent” producers are starting to walk back FY20 budgets. Smaller operators seem relatively opaque at this point, as many of them are running somewhat ‘binary’ development programs (1-2 rigs/frac crews). The risk to OFS pricing is real in 1Q20, and the “worse before it gets better” consensus view could see yet another down cut to 2H20 numbers. On our numbers based on what has been disclosed, the public NAM E&P collective is poised to lower spending by the consensus ~10% Y/Y, as was priced into OFS at YE19 (OIH down 34% since/YTD). This would suggest that the market is already pricing in a spending falloff in FY20, one perhaps much larger than currently expected. We know that HAL is leaning more toward margins/returns vs. utilization than it has in recent years, and that SLB continues to rationalize its fit-for-basin footprint. Well-capitalized, smaller providers are high grading equipment (some incremental in the case of PUMP/LBRT), but we suspect that another year of below breakeven frac pricing to accelerate net attrition.
PUMP stock traded nearly 10% higher yday (vs. OIH -4%) following a positive update in which the company provided a solid, pre-guide beat of prior consensus (4Q19 ann EBITDA of ~$20M per spread-year, and at the upper end of the active spread range provided on the last call). The company also disclosed the (known) early Jan deployment of its first DuraStim spread, and provided a ‘no-change’ update with regard to its ongoing SEC audit review (internally, no findings to-date that would warrant financial restatement). The disclosed YE19 net cash balance implies solid FCF execution on the quarter. The positive 4Q pre-guide is a welcomed reprieve from the demoralizing market/energy fallout over the past several weeks, and EBITDA/spread results re-establish PUMP as the foremost execution leader in WR Pumping (perhaps evidence of at least *some* bifurcation in a challenged market).
4Q19 E&P earnings has been a slow drip thus far, but heats up in earnest this week with prints from five of the largest producers (CXO, DVN, FANG, PXD, PE). These five companies collectively accounted for approximately ~$12B of USL-directed D&C capex in 2019, which illustratively is roughly the size of HAL’s 2019 NAM rev. CXO, DVN and FANG reported AMC yesterday and on aggregate reduced 4Q19 capex by 13% sequentially and collectively guided to a relatively benign 4% decrease in 2020 capex, with modest increase by FANG offsetting expected declines from CXO and DVN. PE and PXD report AMC today, with PE having already announced its 2020 capex budget (+16% standalone; -20% pro forma for JAG acquisition) and PXD informally guiding to a ~17% increase in total 2020 spending. In aggregate, the most recent guides suggest a modest 2% decline in 2020 capex from the group, considerably better than the double-digit declines expected for overall USL spending (smaller/privates likely lower).
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