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.
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Our take – A light in dark places, when all other lights go out. From the first line in our 1Q EPS note – “In an otherwise dismal tape for OFS equities, NESR quietly printed another solid 1Q19 result”. Flash forward to today, another solid result will likely see a rare consensus estimate raise (against an even more depressed OFS backdrop than a quarter ago). The 2Q EBITDA beat was an important result for those investors wary of recent margin lumpiness and continued profitability bleed (a symptom of regional/segment expansion, although still subordinate to topline growth for the NESR thesis, in our view). While margin lumpiness could persist as NESR accelerates growth through 2H19, we note that consistently solid execution through the first year as a public company also lends further credence to MENA as the healthiest among the global OFS regions (an idea perhaps underserved by commentary from larger, diversified and more mature peers). Share liquidity remains the primary issue for NESR equity, and continued sector UP has driven even more of the market away from OFS. NESR remains the L-T int’l play. We maintain our OP rating and YE19 PT of $22 (unch – street high), based on 9.0x (unch) our FY20 EBITDA of $245M (up from $241M – also street high).
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).
NESR reported 2Q19 earnings this morning and is hosting a conference call to review results today (08/07) at 9am ET (8am CT).
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.
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.
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).
Late last week, we published a 2Q OFS earnings preview (link) that was perhaps a bit more optimistic than recent OFS performance would reflect in the broader energy market. Our thesis is simple – with recent underperformance having captured the impending negative revision across the sector, another down-cut to OFS capex (particularly in frac) could drive stronger-than-expected FCF through the balance of FY19. Nearly every company that we caught up with alluded to further capex reductions in response to E&P budget exhaustion. With OFS growth/reactivation capex having already been deployed through FY17/18 (e-frac overhaul notwithstanding – although we see slower adoption) ) the evolution of a lower-growth E&P spending paradigm over the coming years could portend a more stable & sustainable FCF environment for NAM OFS.
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.
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