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.
'Slipsco’ acquisition aside, strong FCF should bridge the NAM collapse as global upstream sees a healthy rebalance. Many ‘hindsight is 2020’ themes to connect across the market broadly, but for TS the recent Ipsco acquisition is truly a case of unfortunate timing. The 1Q20 print was good considering the March falloff in L48 rig activity, and FCF generation was again solid in what is typically a seasonally weak cash flow quarter. However, the 2Q20 guide to a 35% revenue decline and single-digit EBITDA margin will likely see out-year street estimates come down sharply.
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.
Last week, we published a few brief, high-level thoughts on five key questions governing a struggling OFS sector. This week, WTI fell to negative territory. The ‘investability’ question is more topical now than ever, and with LO/generalist investors having largely abandoned the space well before the most recent energy market swoon, consensus is clear on this point. Looking ahead, another key question that emerges from neg oil is how the larger producers (particularly those IOCs that are globally diversified in terms of oil asset base) approach US shale from the ‘investability’ perspective. Will the short-cycle nature of the resource prevail (again) after global oil demand normalizes on pandemic recovery, or will the global supply balance irreversibly shift back toward the advantaged economics (lower breakeven) of int’l land/offshore? The survival of OFS depends on that answer.
CHOW – Model Updates – WR Diversifieds. Heading into what we anticipate will be a messy/noisy 1Q20 earnings season for OFS, we’re using our chart-of-the-week spot to both update and dig a bit deeper into model updates for the sector. We’re starting off this week updating our WR Diversified models (SLB-OP, BKR-OP, NESR-OP, HAL-PP, SPN-UP) in response to what we perceive as a deepening downturn, both in NAM (with shale E&Ps potentially having to shut in production due to pipeline constraints) and int’l (the mix of int’l is more short-cycle land/brownfield offshore relative to in FY14, so quicker to response to oil). We are also raising NTM EBITDA multiples across the group, keeping in mind that the market is unlikely to support a FY21 FCF yield lower than 4.0-4.5% (even at trough earnings). We continue to believe that global earnings mix (NAM vs. int’l) improves out of this downturn. We still like SLB over HAL (USL exposure, capital light pivot). BKR is the best balance sheet, although more downside risk to non-OFS segments (our view). NESR is an interesting case of equity dislocation (a KSA production cut at this level could be a headwind, but higher oil, even <$50/bbl, would be supportive of activity/pricing elsewhere in MENA). Model & Price Target updates within.
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