- Service companies have responded slower to higher oil prices than operating companies.
- Some service sectors have been more resilient than others in the Q-4 downturn.
- Overall, U.S. shale appears set for continued growth in 2023.
We have seen a wide range in oil prices during 2022. From the start of the year, when WTI oil was trading in the upper $60s, too late March, where it topped $130 per barrel. In the last six weeks, this closely watched commodity benchmark has collapsed, with WTI briefly trading below $70.
This has also resulted in the stock price of Oilfield Service Companies-OSV fluctuating in response to advances and declines in WTI. Some companies have appeared to be more resilient in market sell-offs, retaining more of their cycle-high levels.
This article will review possible reasons investors have stayed with certain companies and abandoned others as WTI dropped. We will also draw some summary conclusions about what this might portend for 2023.
The Drillers outperform
It’s been a while since we could say that! Looking at the chart above, contract drillers have robustly outperformed the others. Companies like Patterson-UTI (NASDAQ:PTEN) and Helmerich and Payne (NYSE:HP) are the clear winners in this contest. They have retained 85 and 91% of their 2022 stock price highs from peak to trough, respectively.
From a review of their corporate filings, it appears a couple of key factors drove this result. Revenue growth and margin improvement figure prominently in these companies' stock performance.
In the case of PTEN, tightness in Tier I, Super-Spec category has resulted in a virtual sell-out in this class. The PTEN rig count grew from 113 to 132 in 2022, with another four lower-tier customer-funded upgrades to Tier I scheduled for 2023. Tier I rigs can “walk” to the next pad well, saving rig-down time for simple moves and other upgrade pipe handling and pumping capabilities. What’s more impressive is the Tier I day rate growth from the low $20,000’s to the current $40,000’s, which has led to revenue topping $702 mm for Q-3, a 64% increase from the first of the year.
The rise in revenue has been at increasingly profitable terms, bringing EPS-Earnings per Share from -$.038 in Q-4 of 2021 to a positive $0.18 in Q-3 of 2022. With rates at the current levels, the company is seeking and getting longer-term 3-5 year contracts, which will stabilize cash flow at high levels for years to come. This figure may improve still further in the year to come, as was noted in their Q-3 quarterly conference call where CEO Andy Hendricks commented,
“Going into next year, we expect to see further pricing increases as many of our existing contracts roll over, especially in contract drilling. As such, I believe we still have significant upside to our current margins and free cash flow.”
H&P largely echoed the details driving their business, John Lindsay (NYSE:LNN), CEO, commented,
“I’m encouraged to report that our leading-edge pricing levels are now delivering margins in line with that goal. These are results not seen since the 2012, 2014 upcycles. Strong demand from customers, coupled with rollovers of term contracts, should help drive average pricing higher across our active fleet and we believe there is significant momentum heading into fiscal 2023.”
PTEN is trading at an attractive valuation of 5.3X EV/EBITDA despite holding on to most of its high side price. H&P trades a little lower on this basis at 3.25X. Both companies have solid balance sheets and good capital discipline and are considering implementing capital return programs for shareholders in the coming year.
The Big Colors
Halliburton (NYSE:HAL) and Schlumberger (NYSE:SLB) come in second on the category percentage gains retained for the year. HAL has held on to 85% of its high-side gains this year, while arch-competitor SLB is only off 7% at 93%.
A couple of drivers here seem to be responsible for their performance. Revenues are up 20% in the case of SLB, but EPS has doubled since last year. HAL’s revenues are up 15% YoY, but EPS has more than doubled.
Both companies cited growth in key divisions in North America and in the International sector. In the case of HAL, their fracturing fleet is in high demand, while SLB noted their Well Construction business success. Both companies saw margin expansion from the prior quarter, with HAL documenting 16% and SLB citing margins of 19% for the quarter.
High technology leads the business case for both companies, much of which is AI-driven, with lower input costs and personnel intensity. This has been a multi-year investment focus for both companies that now seems to be paying off handsomely. SLB CEO Olivier Le Peuch made bullish comments about the year to come in 2023.
“Turning now to the macro, we have strengthened our view in a multi-year up-cycle as we are on the cusp of yet another year of growth. A significant step-up in investment is required to create supply redundancies, rebalance markets and rebuild global spare capacity to levels that provide for sustainable economic growth. And third, recent OPEC+ decisions and the extension of its framework for cooperation through 2023 are additional factors that will enable operation–operators to invest with a higher degree of confidence in their commodity price assumptions.”
The Frackers
Liberty Energy and ProPetro Holding (NYSE:PUMP) are both generating positive cash flow and earnings and in a position to be raising rates for their pumping services. PUMP grew revenues and cash flow by ~50% YoY. LBRT exceeded that by double to $1.2 bn in Q-3 and tripled cash flow to $157 mm. Both companies have grown EBITDA per fleet to $25-28 mm in the current quarter and see a line of sight for further increases, though Chris Wright of LBRT noted that the rate of increases might moderate in 2023, given current pricing for WTI.
LBRT added upgraded Tier IV six fleets in the quarter from stacked OneStim equipment that was legacy SLB. Other fleets are Tier IV Dual Gas Blend-DGB to reduce diesel consumption. Further growth will come from electric fleets that can get power from either natural gas or directly from the grid. PUMP is also going the DGB route but is ordering new build electric fleets and expects to have 2-fully electric fleets available for a contract beginning in Q-3, 2023.
Given the growth in their top and bottom lines, it’s not hard to understand why investors have chosen to stick with LBRT, particularly with the stock maintaining 88% of its high side share price in the recent sell-off. With a third the size of LBRT, PUMP has been more volatile, dropping nearly 50% over the same time frame.
Water Management and Sand Suppliers
The lower capitalization companies that supply needed materials, water, and sand to fracking operators have not sustained the gains made in the first half of 2022. Aris Water Solutions (NYSE:ARIS) grew revenues YoY by 50%, but EPS fell over the period from $0.69 to $0.02, suggesting that their growth capex is being met through operating cash flow-OCF and at the market share sales. Not scenarios the market is rewarding currently. ARIS has not generated any free cash flow in 2022.
Select Energy Services (NYSE:WTTR) grew revenues by nearly 100% to $375 mm in Q-3 and EPS from -$0.14 to $0.23. Select hasn’t generated any free cash in 2022 and generated funds for growth capex through OCF and share sales.
The two water management companies, WTTR and ARIS, are ending the year down from their highs of about 15% and 25%, respectively.
US Silica Holdings (NYSE:SLCA) is a premiere sand supplier to the fracking industry. It grew revenues over 100% YoY and EPS from -$0.19 to $0.35. The company generated about $175 mm in free cash throughout 2022. The contribution margin per ton was $24 in Q-3, and volumes were 3.5 mm tons. This represents a 20% increase in volumes and a 2.5X increase in contribution margin. The company is down about 40% from mid-year highs, with a legacy debt of ~$1.1 bn hanging over the stock. The company reduced this debt load by $150 mm with free cash over the year. CEO Bryan Shinn noted a very robust environment is developing for 2023.
“We enjoyed a full quarter of price increases to fight inflationary impacts in our industrial segment, realized greater contract coverage and improved prices in sand proppant, and delivered further margin expansion in SandBox last-mile-logistics. Looking out to 2023 our oil and gas segment is in an excellent position for further sequential growth and cash generation.”
Smart Sand (NASDAQ:SND) doubled revenues in their core Bakken and Marcellus areas and took EPS from -$0.29 to $0.06. Contribution margins have ramped from about $8.00 per ton to $16 per ton as of Q-3. The company has suffered historically from crippling breach of contract lawsuits and its dependence on Northern White Sand-NWS, logistically challenged as companies began to shift to in-basin sand a few years ago. The company was optimistic in its outlook for these basins and perhaps a pickup in sales of NWS due to problems stemming from in-basin sand.
SND carries no debt and expects the key Marcellus market to remain strong in the coming year. The collapse of the stock is probably due to some unfortunate commentary coming out of the call. Charles Young, the CEO, commented about the
“We're not seeing a lot of the new Northern White sand supply come back online. There may be some pockets of incremental supply. But with some of the capital constraints out there, and the course reserves of most of the idle mines with the inefficient processing that, that yields, we don't see much, if any, of that capacity returning at the current pricing and margin levels.”
Summary and Your Takeaway
US shale is set up for another growth year of activity, driven primarily by rig reactivations which could add another 50 rigs throughout 2023. Most of the growth in 2022 occurred in the first half, and the rig count has plateaued in the past six months. The tightness in the Super-spec “walking rigs” has restored the drillers to profitability with a long ramp higher in the coming years.
The drillers probably represent the most asymmetric bargains among the service company cadre, with PTEN trading at 5.3X EV/EBITDA and H&P trading at 3.25X EBITDA. They are delivering growth to the market and seem to be able to leverage cash upfront from clients for new rig activations. If that’s not having your cake and eating too…I don’t know what it might be. With rig rates and terms still increasing, 2023 should be another good year for them, and we should see multiple expansions.
It should be no surprise that the frackers are right behind the drillers on the bargaining table. LBRT is trading at 5X EV/EBITDA on an adjusted basis. Debt-free PUMP is even cheaper on this basis at about 3X. As the new rigs come to work, frackers' multiples will adjust higher, with the stock prices reflecting new valuations.
Halliburton and Schlumberger are trading at higher multiples- 12X and 13.6X, respectively. Growth should come from increased cash flow, as in the case of North America, from 50 new rigs tightening equipment and personnel availability, and in the case of International, activity-particularly MENA, from massive new projects kicking in as the GCC countries try to increase output in a few years. In the past, both companies have run at multiples in the upper teens during a growth cycle, and I see no reason they can’t return to those levels in the coming year.
One of the sand suppliers also presents a compelling value given its present level. SLCA is trading at about 8X EV/EBITDA because of its debt load. With their cash flow-$275 mm on a run rate basis and low Capex, this can easily be cut in half over the next couple of years. SND is a more complex picture given its size, about 1/10 that of SLCA. Its contribution margin of $16 per ton is a substantial discount to SLCAs in the mid-$20, suggesting that they are incurring costs dragging the margin down. I consider SND a good bit more speculative than SLCA.
Overall, the service company picture appears to be an attractive setup for growth in the coming year. All the companies we have discussed will probably end 2023 higher than where they are now with the usual oil price caveat understood. Some look more compelling than others, but beauty and value are in the eye of the beholder!