We’ve spent a good portion of the past few weeks catching up with industry contacts across the OFS & producer space, with the aim of getting a better handle on shale shut-ins and the 2H20 outlook. Amongst our USL contacts, sentiment in recent days seems to be increasingly hopeful, with activity expected to materialize in late June/early July. We’re dubious of this timing, although E&Ps seem to be putting shut production back online at incrementally higher oil prices (not much OFS play).
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Quarantine has spawned a legion of retail day traders with seemingly high-risk tolerances and plenty of fresh capital to deploy to beaten down stocks. Call us crazy, but we think this phenomenon partially explains some of the more inexplicable up moves in OFS stocks recently, as +20% daily spikes on zero news has become routine (exacerbated by dwindling cap and thin institutional flows). Within, we analyze Robinhood user ownership data for the stocks in our coverage. We believe the explosion in ownership has contributed to the sharp recovery off the lows but remain wary of a potential unwind from the retail contingent.
YTD, our ‘NAM bucket’ of OFS stocks are down ~60%, where the ‘survivor’ counterparts (SLB, TS, NESR, BKR, among others) are only down ~50%. Since the mid-Mar sector bottom however, the NAM-centric names have outperformed, despite the fact that fundamentals shouldn’t materially improve as long as WTI remains below $50. Entering the year, consensus saw a 10-15% Y/Y decline in NAM spending/activity, whereas now the bogey is a 50-60%+ contraction. We think the market is pricing in too much of a ‘V-shaped’ recovery in NAM activity & earnings, and in fact see rig/crew adds at $35+ WTI as detrimental to OFS cash burn. Perhaps symptomatic of the broader market small cap/beta rally, the NAM vs. ‘survivor’ trade (in our view) is a rare opportunity in which a potential N-T unwind aligns with the longer-term call for better global upstream balance & earnings power recapture for the ‘survivors’ (as US shale becomes a smaller portion of the growth in the next expansionary cycle). While we count HAL in the ‘survivor’ bucket, this performance trend is especially evident in the recent ‘flippening’ of the SLB-HAL EV/EBITDA multiple spread. Traditional valuation metrics have deteriorated, but within we show recent NAM vs. ‘survivor’ performance & EBITDA multiple trends, highlighting that unwind of the trade since mid-Mar (either through ‘survivor’ catch-up, or NAM cool-off) dovetails with our call that structural contraction in US shale is positive for the longer-term outlook of more globally-diversified names.
1Q20 E&P earnings have corroborated the grim 2Q/2H20 outlook for OFS. Activity and pricing are forging new lows as upstream capex is cut in half or worse. Within we tabulate update budget guidance for the largest E&Ps, present respective rig count and frac spread guides, and present a list of choice quotes from each call. Acceptance is the first step to recovery
Through 2.5 weeks of earnings, the bulk of OFS companies have given an honest go at framing the N-T outlook for an otherwise opaque global oil patch. We believe OFS consensus now captures a 50-60% Y/Y spending decline in USL, with a sharper drop-off in frac activity (vs. drilling) as operators shut in production (and perhaps build DUCs for the oil upswing). E&P earnings have ramped up in earnest this week, with operators signaling a ‘flattening’ of production in 2H20 (after a ~20% N-T step down with shut ins), with potential aspirations for (modest) FY21 growth even in a sub-$40 oil environment. To us this is surprising commentary, and runs somewhat counter to the logic laid out in our global upstream rebalancing note (link), in which we argue that a more disciplined, returns-focused USL collective would shy away from growth below $50 WTI (and that the spending mix-shift to int’l offshore would restore OFS earnings power over the medium/longer-term). We received both constructive feedback and pushback from the note, beginnings of what we anticipate will be a vibrant debate over the future of US shale. We think the debate boils down to the “true breakeven cost” of the Permian vs. int’l/offshore activity, and the IOC formula to optimize returns (breakeven advantage non-shale?), cycle time (advantage shale), and other exogenous/geopolitical risks (adv shale?).
We’re down to only a handful of ‘investable’ stocks in our coverage, but in terms of making a longer-term (constructive) case for OFS out of the current downturn, these globally-diversified names are positioned to benefit from what we see as a ‘global rebalancing’ taking place across upstream O&G. USL activity is set to contract substantially in the coming 12-24 months, and we argue that this global mix-shift will continue into the next upcycle, primarily due to 1) E&Ps internalizing ‘returns over growth’, and 2) advantaged economics outside of US shale (where attractive breakevens will no longer be overshadowed by longer cycle times). While timing of a recovery is uncertain, the overall mix-shift away from US shale is a tailwind for OFS earnings power, and this ‘global upstream rebalancing’ dovetails with our ‘survivor’ thesis for SLB, NESR & TS. Additionally, BKR, HAL, NOV, CLB, DRQ, OII & APY play into this theme.
Earnings have ramped up, so we’re keeping this one brief. Have been a bit more long-winded than is necessary of late, with energy earnings now in full swing across all subsectors. This past week, we got a refreshed look at a dynamic 2Q20 NAM collapse, from the perspective of key USL-centric names that reported. The key takeaway – Activity in USL likely to fall 60-65% Q/Q in 2Q20, versus the 40% communicated by SLB/others earlier in the earnings season. Stocks did respond when 2Q guidance was given, which we think has driven some dislocation between those that withheld guidance (ests need to move lower) and those that were more draconian in the outlook (ests adequately reset, at least on a relative basis). In terms of the longer-term ‘survivor’ thesis, no concerted movement among generalists. The recent OFS/small cap rally is more symptomatic of market-wide idiosyncrasies in this this odd COVID-driven tape.
APY reported on Tuesday (stock rallied 26%), while LBRT and RES reported last night (both beats, for what its worth, with stocks up in early trading). So far, the prints/model updates aren’t as bad as initially feared, mostly due to aggressive cost/capex cuts and commentary around balance sheet/cash preservation. It feels as though most companies have decent control of cash burn heading into a historic 2Q collapse, although the magnitude of the 2H20 activity decline is impossible to predict. We’re cautious on any stock rally, oil/earnings driven or otherwise, until higher commodity/spending/activity visibility is achieved.
Across the OFS sector, the near-term focus continues to be on how quickly companies can cut cost and manage decrementals. For NOV, an additional $375M of annualized cost-out (targeted to be achieved through 2Q-4Q20) should somewhat soften the margin blow of an otherwise unprecedented collapse in equipment activity. However, the sheer rate-of-decline in both NAM and certain int’l geomarkets makes for difficult cost control in the coming quarter. Following more severe revenue & margin contraction embedded in the 2Q guide (appreciative of NOV for providing guidance), we are modeling more modest decrementals in 2H20 and FY21 relative to those exhibited in the prior downturn (FY15/16). We expect Wellbore Tech to see the bulk of the cost-out in the coming quarters. CAPS should continue to see relative topline & margin resilience given a more diversified int’l/offshore hue, while Rig Tech could see play in the aftermarket as additional offshore drillers undergo restructuring and assets change hands (our view). Maintain UP and $9 YE20 PT. We see fairly solid FCF in FY20/21.
NOV reported 1Q20 earnings AMC today (4/27/20) and is hosting a call tmrw (04/28) at 11am ET. Revenue and EBITDA missed WR/street by ~5% apiece, as the intra-quarter slide in crude prices (beginning in Feb) and late Mar collapse in activity likely weighed on shorter-cycle cap equipment activity. Wellbore Tech & Rig Tech saw worse-than-expected topline decline (rev push out?) and more severe decremental margins than previously guided. CAPS revenue was in-line, while margins surprised to the upside. NOV expects “likely one of the most severe downturns” in industry history “to get much worse in the second quarter”, and has upsized its cost-out plan by $395M (465bps on FY19 rev). It appears to us that the company will see heightened (relative) headwinds as OFS customers cut capex deeper-than-expected (SLB, HAL, BKR, others), and key offshore drilling customers see a likely multi-year cycle reset (see DO BK).
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