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.
We had previously called out PD (NC) as the only driller poised for a rig count beat vs. prior consensus, with HP & ESI (NC) in-line and NBR & PTEN tracking to lower 3Q exit rates. HP did fall largely in consensus on revenue, with its rig count within the prior guidance range and FCF execution offsetting the modest downward revision. PTEN hit its prior guidance of 142 average rigs operating (as it provides monthly rig count updates), but the 3Q exit rate was lower than we had previously modeled, leading to a nudge-down of 4Q ests. NBR L48 rig count of 108 fell below the prior soft guide of 110-111, and the 4Q bogey of 100 L48 rigs captures the similarly lower/expect 3Q exit. PD (NC) hit revenue, but our tracker did not pick up the modestly worse/expected US drilling decline (perhaps due to the mix of Tier-1 vs. Tier-2 rigs that rolled off).
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.
Our Take – Walking the FCF tightrope and addressing key int’l concerns. Another quarter, another “not dead yet” short cover. Fundamentally, solid recovery in int’l margins (which should see follow-through when two MX platforms finally deploy in Dec) was timely given the deterioration in the L48 outlook. The drillers seem to be signaling a 4Q USL rig bottom (though TS remains cautious) and we agree based on DUC drawdown in FY20, but sustained int’l volume and margin improvement is ultimately the crux of a stronger FCF/deleveraging thesis. So, what are the int’l pushback points? 1) LatAm, where ARG exposure remains IOC-heavy with renewed, multi-year rigs (runway post-election) & VZ where waiver downside is de minimus for EBITDA, and 2) Mid East, where broad-based renewals insulate NBR from OPEC-cut activity decline (and regional declines broadly could help push out subscale peers as the rig market consolidates). Maintain OP and $4 PT, based on 5.0x FY20 EBITDA of $872MM (down slightly on the L48 outlook). Multiple discount to ’09-’14 cycle avg of 5.5x. Valuation implies $14MM/tier 1 USL rig & $12MM/int’l rig (EV split by EBITDA).
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).
NBR reported 3Q19 earnings AMC today and is hosting a call tmrw (10/30) at 11am ET. US drilling results were largely in line with our expectations, and although NBR effectively reiterated the popular L48 rig bottom (in its 4Q guide of 100 rigs vs 99 currently active), the company anticipates some margin pressure (likely pricing, in our view). This quarter, it was int’l drilling that surprised to the upside after several quarters of underwhelming results, driven by cost takeout, and NBR expects similar profitability (but better FCF) from int’l in 4Q (better than our prior ests). Capex came in a bit hot, and FY19 could see spending inch north of the $400M bogey, but better/expected FCF in 3Q (despite semiannual interest) reinforce the full year net debt reduction target of more than $200M.
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.
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