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).
Getting aggressive on cost cuts as focus shifts to downturn duration, FCF & the ’24 notes. The deepwater drilling market had just turned the corner in FY19, prior to what has been a disastrous 2020 for OFS. Fortunately, OII had been padding its balance sheet with cash in conjunction with the prior offshore expansion. Decisive cost reductions carried 1Q20, and should be supportive of positive FCF through the balance of FY20. In our view however, FY21 looks a bit more challenged from a cash flow perspective, in lieu of a market recovery and lack of WC unwind. Maintain PP, raise YE20 PT to $4 (from $3), based on 10x our FY21 EBITDA of $90M (from $103M).
OII reported 1Q20 earnings AMC yday, and is hosting a call today (5/14) at 11am ET. The company posted a modest topline beat, and solid EBIT beats across nearly all reporting segments as deeper-than-expected cost cuts were realized. While 2Q/full year 2020 guidance was withdrawn, the company established a N-T cost-out target of $125-160M annualized (650-700bps on FY19 revenue) by YE20 (inclusive of $35-40M of lower depreciation, partially tied to the $379M impairment taken in 1Q20). To-date, OII has achieved $70M of the cost benefit, and cited further cash tax declines and a ~20% Y/Y decrease in FY20 capex as additional balance sheet tailwinds. In sum, the company expects to generate positive FCF in FY20, with the nearest & major debt maturity of $500M notes due Nov ’24 (trading at 62). We do need more color on revolver covenant relief, given what we perceive to be a challenged 55% capitalization ratio (on the back of 1Q20 write downs).
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.
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.
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