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.
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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 – Lower peaks & deeper troughs, but LBRT still among the most ‘investable’ in frac. The 3Q result & 4Q outlook indicate profitability can remain differentiated on an absolute basis, but LBRT’s current scale exposes it to market wide directionality. 4Q EBITDA/spread is likely to decrease by over 50% from 2Q for the 2nd straight year, this time from a 40% lower base. Per-spread profitability declines in 4Q will be inflated by the decision to keep all crews active indefinitely. There is a difference between LBRT keeping spreads active at ~$7M/spread vs. peers working below cash flow breakeven, and the decision will look better if activity snaps back as expected in 1Q. However, we’re increasingly wary of the elasticity of incremental demand and are coming to terms with 2020 being another year of lower peaks & deeper troughs for frac, inclusive of LBRT. A culling is necessary for LBRT to regain its former glory, in our view. Maintain OP for LBRT as we view it as the most investable stock in a high-risk, high reward subsector, lower PT to $12 (from $14).
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).
Our take – Tough EBITDA/spread decline on pricing pressure, 4Q falloff “may be more intense than in 2018”. LBRT’s $12.1 million annualized EBITDA/spread was worse than our estimated $14.5 million, with pricing pressure offsetting the relative topline stability as the company began to feel the effects of customer exhaustion midway through 3Q. Incrementally cautious is the 4Q outlook, in which LBRT cited a falloff that “may be more intense than in 2018”, implying at least a 15% revenue decline on the back of continued slowdown/utilization gaps. Unclear if LBRT expects further pricing degradation from here, but did cite continued oversupply as ‘holding down pricing’ until a better balance is realized through attrition/demand improvement. Despite the operational challenges, LBRT drove better-than-expected FCF, which we’ve contended could set up for accelerated shareholder returns. We look to further 4Q guidance/capital allocation color on the call tomorrow (10am ET).
The outlook for 3Q frac activity got incrementally worse over the past month, with our revised QoQ decline falling to 10% (from an 8% 3Q decline estimate last month). Our outlook for the Permian (tracking -9% QoQ) was relatively unchanged, while the EF outlook improved modestly and the rest of the basins (particularly NE) fell materially. A stark September falloff in the Permian/Bakken punctuates a negative (but largely expected) step-down in activity with the early creep-in of E&P exhaustion. Given the ~2-month lag from frac->production, we believe the Aug-Sep falloff could portend an Oct-Nov oil growth decline in USL as E&Ps pack it in early for FY19 spending.
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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