The horizontal drilling and the hydraulic fracturing technology are some of the latest developments in the hydrocarbon market that boosted the shale oil and gas production and brought a revolution in the oil and gas industry.
Apart from the E&P and the midstream companies, the oilfield companies also belong to the primary beneficiaries from the tsunami of new investments in the energy patch. You can find more information and detailed maps about all these beneficiaries and their plans in my articles here, here and here.
The long term trends are very favorable to the oilfield services industry for some more reasons. It does not matter whether the well is a gusher or a dry hole, the oilfield companies will get paid either way. I also believe that the oil price will remain above $80 for the foreseeable future, and this spurs many companies to drill. Moreover, the producers are looking to replenish their reserves, and several countries rely on oil prices to achieve their budget targets (i.e. Venezuela, Saudi Arabia, Nigeria, Iran). On top of that, several other countries (i.e. Mexico, Brazil) struggle to keep up production which has been declining during the last years.
After all, there will always be a baseline of drilling activity going forward, that extends from North America to new exploration areas such as Africa, the Southeast Asia, the Mediterranean, and South America.
This is why, I decided to write few articles about the oilfield services companies, which will be a very useful tool for all the fundamentalist investors who try to identify the undervalued and the overvalued players along with some potential acquisition targets. This series captures all the players with market cap up to ~$3 billion.
In the first part of this series, I pointed out a significant distinction that I want to repeat here again. There is a lot of opportunity and lack of availability of rigs in some key international markets, while the demand in North America is flat or trending downwards. In North America, there is a fierce competition in the oilfield sector during the last couple of years that hurts the prices and reduces the margins for the majority of the companies. Add on this, some recurring problems that the companies encounter here (i.e. spring break up in Canada due to the severe weather in winter), and the final picture is not encouraging to me.
On the contrary, Africa is one of the key international markets which is doing fine. According to the latest news, the drilling activity is ramping up in several African countries, and the drillers with exposure to Africa enjoy 35-40% EBITDA margins because there are less than 50 rigs on the continent currently.
Another region with very favorable supply/demand fundamentals is South America, primarily in Colombia, Ecuador, Peru and Brazil. This keeps the day rates up in these countries, and this trend does not seem to change in the foreseeable future. A rig is not built overnight.
Brazil's National Petroleum Agency will auction off exploration licenses this May for the first time in five years. 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.
In the meantime, the majority of the oilfield companies have problems with their operations in North America as discussed below. To buck this trend, several companies of the sector seek to expand to the international markets where demand exceeds supply.
Digging Into The Fundamentals
The key metrics and the outlook are of high importance any time I am doing my due diligence. According to the latest Q1 2013 reports, the key ratios for this second group of companies from the oilfield services sector are shown below:
EV: Enterprise Value
LT: Long Term
EBITDA* : Estimated EBITDA (annualized).
Tesco Corporation (TESO) has the best balance sheet among the aforementioned companies, primarily due to the non-existent long term debt. The company's margins are also decent. The market seems to like the international exposure and the lack of debt, giving Tesco a good premium currently.
Tesco is another company that enjoys the benefits of its international exposure despite the domestic challenges. In Q1 2013, Tesco acknowledged the challenges created by lower North America rig activity, while the company's tubular services business increased primarily in the Asia Pacific region and Latin America. This resulted in improvements in both revenue and operating income during Q1 2013 as compared to Q1 and Q4 2012.
According to Q1 2013 report, the company's Top Drive business has also been negatively impacted by the slowdown in North America, and Tesco's strategy was to shift its focus to international markets, especially to Russia, the Middle East, and Latin America. This strategy has partially offset the decline it experienced in North America.
RPC Inc. (RES) has also a good balance sheet due to the negligible debt. This is why RPC trades at a very good premium to its book value, carrying a rich EV/EBITDA ratio.
RPC provides a broad range of specialized oilfield services and equipment primarily to the United States, including the Gulf of Mexico, and in selected international markets.
After a challenging Q4 2012 due to the weakness of the U.S. market, the weak results continued in Q1 2013. This weak demand and prices led to disappointing first-quarter results for the oilfield services provider. President and CEO Richard Hubbell said competition remains fierce despite lower U.S. rig counts and is forcing the company to lower its rates. Apparently, the company's small exposure to a couple of international markets did not offset the weak demand in North America. I believe RPC has to expedite its growth strategy and expand to some key international markets like South America and Africa.
Precision Drilling (PDS), Patterson-UTI Energy (PTEN) are fairly priced, while Newpark Resources (NR) enjoys a significant premium. However, Newpark's metrics are not superior to Precision's or Patterson's to justify this premium. The primary underlying reason for Newpark's rich valuation stems from its international exposure and the bright outlook associated with the international markets where Newpark operates.
In Q1 2013, Newpark's international revenues from the fluids business were up 21% year-over-year, reflecting strong gains across all regions. The Middle East market is one of the international markets where Newpark has growing operations.
The secondary reason that has inflated Newpark's valuation is the fact that the company authorized a second $50 million share repurchase program, following the $50 million repurchase program completed in Q4 2012.
With a focus on the Northern U.S. markets, Patterson-UTI sees increased price competition in drilling as some competitors seek to regain lost share with lower pricing. In pressure pumping, the company sees relatively stable pricing going forward, but at slightly lower average pricing than the first quarter due to pricing adjustments following the expiration of certain term agreements.
Precision Drilling is another company with a focus on the Northern U.S. markets. This is why, Precision Drilling was 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 the subdued North American industry 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 Q1 2013, has put pressure on industry utilization and day rates.
In its Q1 2013 report, Precision Drilling also noted that drilling activity has been lower in Canada and the United States compared to this time last year. In the Q1 2013 report, Precision Drilling pointed out that the U.S. active land drilling rig count was down about 11% from the same point last year, and the Canadian active land drilling rig count was down about 14%. Despite the active industry 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. All in all, Precision's announced international deployments are going well, according to the company's Q1 2013 report.
After all, I am not bullish on any of the five aforementioned companies at the current levels, because I do not consider any of them to be undervalued.
There is one more part coming, where I plan to uncover some more good short and long candidates, along with some very interesting plays for the income seekers. Once I am done with them, I'll cover the oilfield companies that operate offshore. After all, stay tuned folks because more "drilling" into the companies' fundamentals is coming soon.