In times of uncertainty, lean into field fundamentals (and valuation). There were two key, but distinct negative takeaways from last week’s 2Q19 result. First, fleet profitability retreated, and the N-T utilization outlook softened. Second, the company announced an Audit Committee review of potential controls deficiencies, which discovered that “incorrect expenses” were filed by the CEO/CFO (albeit in amount of a G&A rounding error). We understand the selloff, as investors remain in “wait and see” mode regarding audit findings. Rather than retrench to this holding pattern, we are leaning into field fundamentals, and believe that valuation (now below equipment replacement) encapsulates the audit overhang. We reiterate OP, and lower our YE19 PT to $27 (from $33) based on 5.5x our FY20 EBITDA.
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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.
Results underwhelmed street expectations, as PUMP dropped a crew in the quarter and annualized EBITDA/spread fell to $15.6M (inclusive of fluid ends, from $19.0M in 1Q). Fleet profitability is still among the top of the peer group, but 25 spread guidance for 3Q falls a crew short of prior consensus. However, market focus will be on the extenuating circumstances around CEO and CFO conduct and the Audit Committee’s finding of “incorrectly recorded” expense items. Depending on Audit Committee findings and subsequent disclosure, potential CEO/CFO misconduct could not only negatively impact PUMP’s relationships with existing customers (currently rooted with the CEO), but could also reverberate across a NAM OFS sector that is already perceived to be structurally impaired. We reserve additional analysis until further disclosure regarding Audit Committee findings (likely within 30 days).
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).
A well-executed 2Q19 makes an underwhelming 4Q18 appear increasingly aberrational and LBRT should be significantly more well-prepared this year for the detriments of YE budget exhaustion. Record high efficiency in 2Q speaks to LBRT’s success in optimizing a relatively new Permian operation amidst a stingy frac market. LBRT has firmly established itself as a top-2 frac provider, and while investors will have to live with the idiosyncrasies of LBRT’s basin exposure and more volatile profitability, it has a more direct path towards maximizing FCF/returns than its closer competitor. LBRT has the balance sheet to withstand periods of weakness and could capitalize on distressed M&A if demand remains subdued. We think LBRT is more likely to focus on FCF stability and increasing shareholder returns, however. Maintain OP and $20 PT based on 5.5x FY20 EBITDA, in-line w/ peer multiples.
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.
2Q results were solid and headlined by a 12% EBITDA beat (+10% vs. WR) as EBITDA/fleet improved 4% to $16.1M. The outlook was terse but neutral, with the expectation for utilization to remain high through 3Q and working with customers to ease the impact from budget exhaustion in 4Q. A reduced cash balance suggests higher-than-expected cash burn during 2Q which appears to be driven by working capital. In aggregate, the print reinforces LBRT’s position as one of the few premier pressure pumpers, but the commentary on the call surrounding the magnitude of the potential 4Q drop-off and capital allocation strategies should be more influential on the stock price tomorrow (07/31/19).
An acceleration of May/June filings in the Permian/Bakken suggests a steady grind higher from the March 1Q peak, while auxiliary basins (namely Anadarko & Northeast) remain lumpy. Nevertheless, 2Q turned out to be a modest growth quarter for USL frac activity. On the one hand, Rystad data squares with E&P commentary around a “pull forward” of 2H activity (in the context of YE budget exhaustion). On the other hand, the data update also overstates frac revenue growth for the handful of OFS companies that have reported (all else equal). Bottom line, if higher-than-expected Rystad frac growth is correct for 2Q, then L48 production should still see positive supply adjustments in lieu of counter-seasonal inventory builds. Also, OFS really needs to stop shedding price.
Last year, we launched RES UP due to what we viewed as FCF yield/return upside for frac newcomers PUMP/LBRT, and that the RES multiple would compress with its dividend yield premium. The pumping market has proven much more difficult in FY19 (for all players), and concurrent activity/pricing erosion & RES’ need to organically replace an aging portion of its fleet came to a head in 2Q earnings as significant cash burn and lack of visibility compelled RES to suspend its regular $0.05/sh dividend (3-4% yield). Moreover, the company did not provide guidance and cut FY19 capex (backing off coiled tubing orders), a signal to the market that the bottom is not yet in for earnings. As such, we are lowering estimates, maintaining RES Underperform, and lowering our YE19 PT to $6 (from $8) based on 5.5x (unch) FY20 EBITDA. We believe 5.5x NTM EBITDA is fair for the WR Pumping peers set, in-line with the group 5-6x mid-cycle multiples over previous OFS cycles.
This morning (07/24/19), RES reported a modest 2Q19 earnings miss across revenue and EBITDA, below street expectations for more of a “bounce back” quarter. Revenue, EBITDA, and margins did improve sequentially, as the company continues to shift away from a prior ‘spot market’ commercial model. However, the 2H19 outlook remains challenged, and we believe that RES (given heightened attrition over its older pumping fleet) does not have the capex reduction levers to offset near-term earnings uncertainty – as do other frac peers. The company burned appreciable cash due to a significant collections build. On the call, we look for more color on the near-term activity outlook, FY19 capex guide, and commentary around working capital friction.
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