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.
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.
To kick off what we viewed to be a make-or-break year for US shale & OFS (mostly break for the equities of late, but OFS is flat YTD – score reset), we published our first US Productivity Report (link). In the report, we postulated that a lower E&P spending cadence, combined with productivity frictions across key shale basins, would yield underwhelming US supply growth (and likely alter the market perception of shale growth over the coming years). Since then, demand considerations (Margolin link) and US-China (& US-Iran) tweets have dominated the oil tape, but US supply is still a crucial piece of the crude puzzle, and we think it important to revisit this (mainly in pictures/charts) ahead of SLB’s commentary tomorrow morning (7/19/19).
In light of particularly morose investor meetings in recent weeks, perhaps the OFS sector should call out a Weatherford fishing hand to retrieve buyside sentiment. In our view, an impending negative revision to 2H19 NAM estimates is largely priced into an OFS sector that has underperformed the XLE by 400bps YTD (and the commodity even more substantially). With the expectation that US E&P spending growth will moderate over the next 3-5 years, and that oil prices will remain range bound, OFS FCF will become increasingly scrutinized in the context of appreciably lower earnings power (compared to prior cycles). Into 2Q earnings, we see further capex reductions and upside to FCF as a powerful positive catalyst against an otherwise negative macro backdrop for OFS.
Wishing our clients/corporate compatriots a happy & safe July 4th – if we had to pick a song that embodies both the holiday and the embattled, but unyielding spirit of the OFS sector – Johnny Cash Ragged old Flag. With 2Q earnings looming and sentiment dragging along an unquantifiable bottom, the key question into 2H19 is whether the upstream spending mix shift, from USL to int’l, can help our global coverage partially break away from the hypercyclical whims of US E&Ps. A contrarian bull case – with adequate OFS growth/reactivation capital having been steadily deployed from 2H16-1H19, a lower “sustaining” shale activity trajectory could yield appreciable upside to USL FCF (primarily for SLB, HAL, and other geographically-diversified SMID cap service names). WR Drilling is poised for robust FCF generation (dayrate stability would likely OP expectations), while WR Pumping has identified the pitfalls of rapid e-frac adoption. Capital allocation will continue to dominate the OFS narrative, and 2H19 conservatism might do more to insulate OFS from USL spending trends than would upside to int’l/offshore activity.
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