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)
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.
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.
The stark contrast between the (pre-guided) 1Q19 disappointment and strong 2Q beat underscores how lumpy the upstream capital equipment market continues to be. Encouragingly, NOV’s revenue mix is shifting steadily toward more stable int’l/offshore streams, which should improve both lumpiness and margins moving forward. In our view, a positive 3Q guide/outlook should assuage fears of appreciable NAM friction through 2H19, and shift the focus toward a “normalized” growth/margin progression in FY20. We are raising estimates, but have difficulty conceptualizing much more than +9% topline growth and 35% incremental EBITDA margins (as prescribed per segment on today’s call). As with CLB 2Q (link) – the conclusion for NOV is that int’l/offshore tailwinds are stabilizing estimates, but the FCF outlook is not (yet) supportive of stock upside. We maintain NOV Underperform and YE19 PT of $20, based on 9x (down from 9.5x) our FY20 EBITDA of $1,026 million (up from $950 million). The target multipl
NOV reported 2Q19 earnings AMC today and is hosting a call tomorrow (7/30) at 11am ET. NOV posted a solid 2Q beat across-the-board, with revenue of $2,123M topping cons by 2%, and stronger incremental margins driving a 10% EBITDA beat. Wellbore and Rig Tech fueled the topline beat, although C&P also came in at the upper end of the prior rev/margin range. The order book saw healthy growth during the quarter, led by the largest quarterly C&P order intake in 5 years. One potential sore spot was the $190M working capital build (led by DSOs) that drove another appreciable cash burn in the quarter – a customer spending trend that NOV called out as an enduring headwind in the upstream austerity paradigm. Results include a $5.4B write down of goodwill/fixed assets, and the company also recognized $399M in charges related to broader cost-out initiatives. The 3Q guide is paramount to gaining investor confidence amidst cap equipment lumpiness exhibited in recent quarters.
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.
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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