News flow from OFS, and the energy sector more broadly, has been relatively muted as of late. For OFS, we are in a transitionary phase in which the market has already digested 4Q earnings and the volley of 1Q preannouncements has yet to strike. Perhaps no news is good news, at least for now, but the relative tranquility speaks to the market’s receptiveness (or wait-and-see approach) regarding the capital discipline push across upstream O&G. This dynamic has also limited the pool of potential buyers to spur any (much-needed) consolidation in the sector and has effectively shut the IPO window, as new capital remains elusive. On that note, we have experienced a marked uptick in generalist inbounds, which indicates that the sector-wide overhaul is starting to bear fruit. Inquiries have even extended to the more commoditized and beleaguered parts of the sector.
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In tandem with our 4Q Earnings Roundup (link), we are updating our OFS macro/activity views. Like many since the 2016 oil trough, this most recent OFS earnings season was marked by cautious optimism – caution in the context of the precipitous YE18 decline in oil and activity levels, and optimism given a more supportive commodity backdrop. Nevertheless, longer-term structural changes are afoot in upstream O&G, as 4Q18 earnings also saw a coordinated E&P pivot to capital conservatism, returns, and cash flow (the likes of which has not been seen so uniformly). OFS was quick to mimic this signaled discipline, and now most of our USL-centric coverage faces an unprecedented lack of demand visibility (ironically, in an improving-oil landscape). Our macro model updates reflect the bottom that we feel is in for both upstream spending and sentiment in 2019.
Market focus elsewhere in energy, but stock selection prospects within OFS. We remain Overweight in OFS given our bullish Wolfe Energy oil view ($67 Brent in ’19, $80 Brent in ’20), but acknowledge that IOC/Refining are the preferable Energy plays given advantaged EPS leverage to oil (unique to this cycle). Nevertheless, we see notable stock selection opportunities within OFS, which largely dovetail with 1) the IOC growth strategy in shale, and/or 2) positioning within a more moderated int’l upcycle.
One if by land, two if by IOC. Terrible way of plugging this week’s marketing trip to Boston, but wanted to flag a key theme from meetings. IOC (Margolin) remains the in-focus energy sector given counter-cyclical growth and leverage to oil prices (unique to this cycle). It seems that sentiment toward E&P and OFS are unequivocally linked, but beyond what we would point out as oil-driven support for int’l capex and OFS EPS power, E&P discipline in shale yields OFS stock selection opportunities based on known IOC alignment in USL. Most of our top picks, and several that we don’t cover, stand to OP from outsized exposure to IOCs in USL, with crude supply tailwinds to boot.
It’s a headline-heavy week for energy investors amidst the dueling analyst days for Chevron and Exxon. Our focus today belongs to APY (OP) however, which is hosting its inaugural investor day as a publicly-trade entity. To us, the event marks the transition from the “introductory” phase of APY to the calibration stage whereby underlying earnings power becomes more apparent. The event is timely with respect to recent revelations on legacy decline rates from E&P conference calls and the corresponding opportunity for artificial lift. It’s unclear whether FY19 guidance will be introduced, though consensus appears overly conservative (+3% increase in FY19 rev/EBITDA) and sets an attractively low bar. We’re looking forward to learning about APY’s “value creation framework” and the timing of potential shareholder returns. We will circle back after the event.
This week, IOC analyst Sam Margolin published a E&P ‘19 Supply (link) note that aggregated production guidance among US E&Ps (and IOC players). He asserts that guidance implies +0.8-1.0MM US black oil growth from 4Q18/4Q19, appreciably below the +1.6MM TTM cadence and notably back-end weighted. Recall in our Jan US Productivity Note (link), our bottom-up WR Production model cited appreciable downside to US growth by way of 1) E&P underspend, 2) US productivity rollover (new prod/well), and 3) decline rate acceleration; the base case of +1.0MM US black oil growth exit-exit (+1.3MM YoY avg) was predicated on +10% E&P capex growth in USL, productivity held constant. Some OFS deflation accounts for the difference in activity needed to reach our/Margolin’s conclusion, but thesis stands – 1) underspend could yield a 1H19 US oil shortfall in-step with lower imports, 2) productivity declines could become more evident as E&Ps ramp D&C in 2H19, and 3) unlike in ‘18, back-weighted growth in ‘19 will be absorbed by an IMO 2020 call on light-sweet.
No thesis changes (or rating/PT) for APY & SPN, although SPN’s strategic messaging won the day. Solid OFS day with APY adding visibility and clarity to the execution track record, while SPN touted solid non-frac results supplemented by capex discipline. We remain cautious on SPN, simply given the continued lack of clarity around the int’l cycle – although SPN appears to be taking full advantage of swift increases in well complexity, as it aims to deploy outsized growth capex in carving out new design spec niches in DPS, Production, and Technical Solutions.
We are in London marketing this week, and sentiment from across the pond toward energy broadly is similarly-cautious. Shale productivity is top-of-mind given that some demand-driven apprehension has abated. In terms of equities, it seems that much more attention is being spent toward E&P and more downstream segments of the energy value chain, while OFS remains an afterthought. Our pushback to this dynamic is that the ongoing 4Q18 earnings print has largely yielded base 2019 expectations of flat/down spending/activity (continued pricing degradation notwithstanding), while US production growth consensus has only moved higher. Sustainable?
The sheer magnitude of delivery pull-forward drove a shocking 4Q18 print last night (investor surprise was split between “pleasant” and “mortified”), but today’s grim guide affirms our view that the dual-headwind of E&P/OFS capital austerity will pervade through at least 1H19. Offshore markets will continue to recover at a sluggish pace, while budget uncertainty in USL could also pressure NOV’s shorter-cycle offerings. Although stable/defensible, our sub-5% FCF yield in both ’19/’20 does imply dividend upside, but beyond the $500MM buyback, NOV has prioritized growth for which equity markets are not yet ready to capitalize. Timing-wise, we see better opportunities elsewhere in OFS.
Tough 4Q18 print and 1Q19 guide for LBRT (link), which elucidates that even LBRT’s Rockies-centric throughput model is not completely insulated from spot market degradation. As it relates to the read-through to PUMP in early ’19 (post pre-announcement - link), the negative LBRT tape does force us to more carefully differentiate between various “dedicated” commercial models in the context of a full USL cycle. We had previously categorized LBRT’s Throughput Thesis as one rooted in operational efficiency (stages/day) to drive EBITDA, irrespective of pricing, while PUMP’s Customer Centric model is arguably more durable through-the-cycle. While utilization is ultimately the key factor, we believe PUMP’s approach works principally due to advantaged operational visibility, which allows for more efficient job planning (and cost management).
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