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.
Wanted to flag this BBG story (link), in which DO (NC) was cited as recouping a $9.7M CARES tax benefit to pay out executives through bankruptcy. Of course, taking this story simplistically at face value may betray the possibility that the cash benefit could have accrued completely to creditors through restructuring (rather than supporting business continuity and employment), but it is a tough look. What OFS mgmt teams say and do in navigating this downturn, including executive comp reduction and allocation of any government aid, has a greater-than-expected (morale) impact on field crews, which in turn is a service quality differentiator (take a look at what MGY said regarding crew quality).
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
A debate is (and should be) brewing over the future of US shale – Is global upstream rebalancing a reality? We put out a note last week (see below) that basically captures the crux of survivorship for the OFS sector. After this downturn, is the ‘returns vs. growth’ mantra going to 1) keep a lid on US shale growth and 2) incentivize more balanced (global) upstream investment based more so on breakeven economics (vs. cycle time)? Or, will E&Ps get back to growth sub-$50 oil (like has been suggested by prominent E&Ps, and perhaps an IOC)? Global rebalancing would be restorative to earnings power, and SLB, TS & NESR are our top ways to play, but BKR, NOV & CLB also fall in line with the theme. Wait and see on HAL & APY given the NAM exposure.
1Q20 OFS earnings have largely wrapped up to this point, and the 2Q pain is fairly well understood (zero 2H20 visibility). Earlier this week, we posited that significant USL contraction would give way to more balanced global upstream spending out of the current downturn, but E&P commentary this week tells a different (and more discouraging tale). At current oil prices, US supply will fall appreciably (up to 20% of Permian production shut-in, how much could be impaired?), but E&Ps are now saying that steady DUC drawdown would occur above $30 WTI. Above $35 WTI, prominent E&Ps are signaling volume growth. The OFS capacity is there, and as always it is incumbent on our companies to push back on a shrinking US shale cost structure. OFS discipline has been elusive, and we doubt that the exodus of labor will be much of a bottleneck to activity growth (not many opportunities in the COVID paradigm).
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.
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.
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