Global exposure is key to our *top pick* designation for TS, but global trade uncertainty remains a key overhang. Earlier this week in a pair of tweets, Trump announced restoration of steel/aluminum tariffs on Argentina, Brazil and France for “massive devaluation” of currency. Given its Arg exposure (annual160kt of tubulars imports), TS traded lower on the news, but lack of price action indicates that the market is discounting follow-through on the latest tweets (a la Turkey on Oct 14th). caught up with the company yday, we see the most likely outcome (if tariffs are enforced) as a <75bps margin impact driven by a manufacturing shift to US/MX/CA and/or rationalization of W-Hemi shipments to the E-Hemi. The higher-level takeaway is that despite our positive view of TS’ FCF potential (HSD % yield) and optimal exposure to the cycle (offshore optionality), we recognize that global trade/steel uncertainty may be untenable to potential (incremental) investors.
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Within, we delve into three key OFS/NAM shale activity topics, including, 1) “DUC exhaustion” in-focus near YE20, 2) a 4Q19 ‘bottom’ for frac utilization(?), and 3) recent US productivity gains through E&P retrenchment, but near/medium-term thesis still intact (productivity headwinds/rollover).
Wednesday AMC, we launched on four additional OFS names, OII (OP), DRQ (UP), WHD (PP), and PD-CA (PP). For OII, pushback came primarily on modest margin growth modeled in Subsea Projects & Products, although investors generally agreed with the better-than-expected FCF premise based on ROV pricing. For DRQ, the key concern was whether our ‘subsea integration’ downside risk (to SPS growth) could be viewed as M&A upside risk for the core wellhead/connector offering (we agree, but valuation is perhaps still a bit rich, despite earnings moving off bottom). WHD is a sellside/investor favorite (for good reason, solid mgmt/cap allocation), although pushback on N-T Products growth was muted given the wait-and-see IOC qualification. PD is a familiar story for most folks, although the timely AlphaAutomation commercialization is a catalyst worth revisiting. We are around today/next week, so don’t hesitate to reach out on any of this.
PUMP will report 3Q19 results today AMC, bringing operational results back into focus (at least temporarily) after the internal review and related inquiries have dominated the narrative since Aug. On Oct 9th, PUMP announced the effectively utilized fleet count for 3Q was 25.1 (vs. 25.6 in 2Q) and guided to 18-20 fleets for 4Q (-26% at midpoint), with no other 3Q/4Q detail provided. Among peers that report/guide to similar effective utilization metrics, FTSI guided to a 26% decrease and legacy Keane guided to a ~23% decline. Figures for PTEN & LBRT depict deployed spreads based on commentary and are thus less comparable, which perhaps also skews the comparability of cited EBITDA/spread metrics. Tables within show 3Q/4Q consensus for PUMP, with figures for peers based on results/guides (or ests in the absence of guidance). We continue to see the market in somewhat of a ‘holding pattern’ on PUMP, with those currently involved leaning into the ~$630/HP valuation (limited downside?), and others waiting for clarity on the SEC review/mgmt re-org.
In this week’s CHOW, we take an early look at implied 2020 capex based on early E&P budgets thus far in 3Q earnings. E&P budgets are tracking down 19%, albeit based on a limited sample and weighed down by massive cuts by OXY, and to a lesser extent, CHK and EQT. We chart the spending data, and then map out OFS exposure to each respective E&P based on YTD frac activity and active rig counts.
Related to ongoing bankruptcy proceedings, Weatherford released updated revenue and EBITDA projections through 2022 earlier this month. Akin to its solvent peers, internal projections have been revised down since the mid-year update with North America weakness offsetting Int’l growth and reduced activity suppressing the uptake of new technology offerings. At the end of 2018, Weatherford thought $1B of EBITDA in 2019 was feasible given its then macro viewpoint. In June, the revised projections pushed $1B of EBITDA to 2021, and under the revised projections, EBITDA tops out at $950M in 2022. The company expects no net growth from activity through 2020, with the incremental growth instead driven by new tech offerings (capital light is trending across OFS). It’s also worth noting that there is not much downside from divestitures baked in, which may signal how tough it has been to sell non-core assets (especially when peers are also more inclined to sell).
CHOW – SLB vs. HAL tale of the tape (more robust review/charts within). SLB and HAL are up 9.2% and 7.5%, respectively, since SLB reported 3Q19 earnings last Friday BMO (HAL reported Monday BMO). The relative strength is somewhat surprising given what we perceived to be mostly neutral prints/calls, and a chunk of the outperformance can likely be attributed to both short covering and/or inordinately low expectations. Still, OFS will gladly take momentum regardless of the source in the current investing climate. Sustaining said momentum has proven to be the more difficult task. In this week’s CHOW, we revisit both sets of results and compare/contrast certain metrics and emerging themes. SLB’s quarter can be summarized as a modest beat and uncertain guide, while HAL modestly missed and issued surprisingly strong guidance. As it stands, much of our tactical positioning call for SLB over HAL into the 3Q print has been deferred to 4Q earnings and the ensuing reveal of SLB’s NAM land portfolio review. We still prefer HAL’s upside L-T.
CHOW – PE/JAG from the OFS perspective – Will E&P consolidation further squeeze service pricing in a lower growth USL environment? Within, we take a look at the rig/frac exposure at play in this week’s PE/JAG tie up, the conclusion being that legacy OFS suppliers for PE are likely to benefit at the expense of those working for JAG (understandably). However, given that PE takes a “squeeze the turnip” approach to service pricing and capital efficiency, we also believe that broader consolidation trends across E&P could further (and permanently) undermine the pricing power of a much more fragmented OFS contingent. While pumpers cite unsustainably low pricing, E&Ps purport continued unit cost tailwinds into FY20, a dislocation in messaging that could inevitably see bad OFS actors acquiesce to larger, post-merger operators in the Permian (unless the frac subsector also consolidates, in the face of low barriers-to-entry). We also observe a HAL/LPI case study which tells of a more amicable equilibrium between OFS, E&P, efficiency and more sustainable investment growth.
From an oil supply side standpoint, the only catalyst that matters is US shale. The LO/generalist market has largely given up on OFS, right before what we believe will be the most impactful structural shift in oil S/D in the past decade – one that benefits OFS, as it stimulates higher calorie int’l/offshore activity and serves as a bbl/$ tailwind for USL drillers and frac. 3Q OFS earnings will be dominated by SLB/HAL/BHGE on the E-Hemi, but equity markets will be looking to the Permian for early indication of the new normal for a ‘steadier state’ US shale complex.
CHOW – Div yields looking increasingly attractive. Where should OFS trade? As the OFS sellside collective (including us) prepares another round of earnings preview, we revisit our 2Q Preview in the context of rising div/FCF yields across OFS. We continue to see more consensus FCF stability vs. associated earnings revisions. With 1) clarity on FY20 NAM spending, 2) demonstrated margin stability despite a contracting NAM environment (aided by int’l tailwinds), and 3) further capex reductions in a broader shift to ‘capital-light’, we believe the S&P500 div yield bogey is tenable for an OFS sector that is both A) at subdued EPS power, and B) overly discounted in terms of near-term growth (or perceived lack thereof). Upside across coverage.
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