My sentiment for the oilfield services sector is very positive due to favorable long-term trends in this industry. Firstly, I believe that oil prices will remain above $80 in the foreseeable future, which is spurring many companies to step up exploration and drill. The oil and gas producers are also looking to replenish their reserves, and many countries rely on oil prices to meet their budget targets (i.e. Venezuela, Saudi Arabia, Nigeria, Iran). On top of that, several nations (i.e. Mexico, Brazil) struggle to keep up production, which has been on a steady decline during the last years.
This makes me believe that there will always be a baseline of drilling activity from North America and Africa, to the Southeast Asia, the Mediterranean, and South America.
In this series, I will cover the oilfield companies with a market cap up to $3 billion. I believe that these articles will be a very useful tool for the value seekers who will identify the undervalued and the overvalued players, along with some potential acquisition targets.
A substantial distinction has to be made here. There is a lot of opportunity and lack of availability of rigs in the international markets, while demand is flat or trending downwards in North America. In North America, there is a fierce competition in the oilfield sector that hurts prices and reduces the operating margin for the majority of the companies. This is why several oilfield companies seek to expand to international markets where demand exceeds supply.
Let's have a look at the following examples that are representative of both trends:
1) Brazil supports the bullish outlook associated with the international markets. Brazil's oil industry hit its peak in 2010. Back then, the country was producing 2.7 million bbl/d and was a net exporter of oil. Since then, the oil production has been on a steady decline. Brazil's National Petroleum Agency estimates that February production was 2 million bbl/d, an 8% slide year over year and a 26% drop from the 2010 peak. Due to the decline in production and a large jump in domestic consumption, the country is now a net importer of petroleum.
Brazil has taken some significant steps to change this situation. The National Petroleum Agency will auction off exploration licenses this May for the first time in five years. Brazil's National Petroleum Agency said in April 2013 that 71 companies had submitted paperwork to qualify for an auction of new licenses to explore for oil and natural gas that is set for May 14-15. The fresh round of bidding is expected to generate a surge in activity across Brazil's oil industry, which was running out of areas to explore in the absence of concession auctions for years now.
2) Schlumberger (SLB) issued a warning recently stating that the North American drilling activity and rig count in 2013 is lighter than it expected. The company's CEO also added that: "We continue to see negative pricing pressure in many product lines in Q1 2013, with active participation from our principal competitors, reinforcing the somewhat unclear outlook for the North America land market at this stage."
3) Precision Drilling Corporation (PDS) was also hurt by lower North American activity. Several factors impacted the company's activity in North America. The primary ones are the depressed natural gas price that limits gas-directed drilling activity, and the oil transportation bottlenecks resulting in regional oil price discounts.
In Q1 2013, Precision's CEO noted that subdued activity levels continue to disappoint many in the industry. The company's drilling rig utilization was down in both Canada and the U.S., partially offset by growth in its international contract drilling business.
According to Kevin Neveu, President and Chief Executive Officer of Precision Drilling, the Canadian industry drilling days were down approximately 10%. He also noted that the plummet in gas directed drilling activity in the United States, which began in late 2011 and continued through the first quarter of this year has put pressure on industry utilization and dayrates.
Precision Drilling also noted that drilling activity has been lower in Canada and the United States in 2013 compared to this time last year. According to Precision, the U.S. active land drilling rig count was down about 11% in April 2013 from the same point last year, and the Canadian active land drilling rig count was down about 14%. Despite the rig count softness in North America, Precision's international business produced almost four times the operating days compared to the first quarter last year. Eight rigs operated continuously during the quarter, and Precision is on track to increase the rig count by five rigs over the next twelve months, according to the company's Q1 2013 report.
4) Total Energy Services (GM:TOTZF) also had growth problems in Q1 2013. Total noted that the slowdown primarily in Canadian drilling and completion activity that began during Q2 2012, continued in Q1 2013.
This slowdown impacted negatively the equipment utilization and resulted in reduced pricing in Total's contract drilling and rentals divisions. Total Energy Services offset this weakness, thanks to the increased sales of its gas compression and process services division.
Digging Into The Fundamentals
I am not a technical analyst but I am a value seeker instead. The ratios and the key metrics are my primary criteria when I evaluate a balance sheet. Fortunately, these fundamental criteria have never betrayed me thus far. After reading all the Q1 2013 reports, I calculated the following numbers for the first group of oilfield companies below:
EV: Enterprise Value
LT: Long Term
EBITDA* : Estimated EBITDA (annualized).
C&J Energy Services (CJES) has a very good balance sheet, and this is why it trades at a good premium to its book value. C&J enjoys decent operating income and EBITDA margins. The long-term debt/equity ratio indicates that the company is not highly leveraged and does not rely much on its credit line to fund its growth.
According to the CEO, the company intends to broaden its footprint by pursuing targeted international expansion, as North America is a difficult environment. As the company said, the fracturing activity in North America in Q1 2013 was weaker than anticipated due to lower utilization levels and the limited increase in rig count across primary areas of operation.
Basic Energy Services (BAS) does not deserve its current premium in my opinion. Basic has one of the worst balance sheet in the sector, and its premium is not justifiable. The negligible operating income margin has deteriorated significantly during the last two quarters, creating a very weak balance sheet in conjunction with an overwhelming debt. Basic pays the price for having operations only in North America. Basic has zero international exposure to mitigate the challenges of the domestic market.
Thanks to its Colombian operations, Pioneer Energy Services offsets its growth problems in North America. In Q1 2013, Pioneer noted that its Colombian operations had higher revenues per day than its domestic drilling rigs. Pioneer had a solid performance in Colombia with an utilization rate of 100%. However, Pioneer continued to see pricing pressure and lower utilization in its drilling operations in South Texas and West Texas.
Parker Drilling relies much on its international operations that generated 40% of the company's total revenue in Q1 2013. Parker strengthened further its international operations recently through the acquisition of ITS. As Parker's CEO noted: "Following due diligence and negotiations during the first quarter, we concluded the acquisition of ITS in April. The addition of this international rental tools and drilling services business adds international presence to our rental tools segment with immediate scale from which to grow and increase profitability, two of our key corporate objectives."
Apart from its domestic operations, Key Energy Services has also international operations in Mexico, Colombia, the Middle East and Russia. The company's international operations look good, excluding Mexico where its activities were impacted by customer activity reductions. In Mexico, Key Energy is currently operating just under half of the rigs that it was operating during the first quarter of the year. While the company reduces its costs in that country, it estimates that this disruption will be short term and is looking for opportunities in other countries for these rigs.
After all, I am not bullish for any of the aforementioned companies at the current levels because I do not consider any of them to be undervalued. In addition, I am bearish on Basic due to its weak balance sheet.
The emerging formations of North America like Bakken, Eagle Ford and Marcellus, have opened up new horizons to the oilfield services companies. However, it is clear that the domestic supply has grown faster than the demand, and the international expansion in key markets is an essential growth factor in this industry.