Over the last years, the horizontal drilling and the hydraulic fracturing technology ignited a revolution in the energy sector, boosting the shale oil and gas production in North America and helping the U.S. economy reduce the unemployment rate significantly.
The oilfield services companies are some of the beneficiaries from this production boom for several reasons. Firstly, it does not matter whether a well is a gusher or a dry hole. The driller will be paid for his services either way. Secondly, the oil and gas producers are 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.
For these reasons, among others, 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 find the oilfield services sector very attractive and thought to write few articles as a useful tool for all the value seekers who try to identify the undervalued and the overvalued players along with some potential acquisition targets. This article captures all the intermediate players that operate primarily onshore with market cap from $3 billion to ~$10 billion.
A Major Distinction
In those articles, I also pointed out that 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 undermines the pricing power of the domestic players, eroding their margins. Add on this:
1) Some recurring problems that the companies encounter in North America (i.e. spring break up in Canada due to the severe weather in winter).
2) The near-term dismal outlook looks challenging across North America, according to the majority of the companies.
Meanwhile, demand exceeds supply in some key international markets and the international expansion is the only way for the domestic oilfield companies to buck the weakness in North America.
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 fewer than 50 rigs on the continent currently. For instance, Africa Oil (OTCPK:AOIFF) and Mart Resources (OTCPK:MAUXF) have a vibrant drilling activity currently in Kenya, Ethiopia and Nigeria as presented in my article here.
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.
After all, the international oilfield companies are primary acquisition targets and will keep attracting a lot of interest from several suitors.
Digging Into The Fundamentals
To determine the financial health of a company, I always dig into the key metrics of the balance sheet and the outlook. These two criteria are of high importance when I am doing my due diligence. According to the latest Q1 2013 reports, the key ratios for this group of oilfield services companies are below:
EV: Enterprise Value
LT: Long Term
EBITDA* : Estimated EBITDA (annualized).
It is clear that Helmerich & Payne (HP) has the best balance sheet. The company's operating and EBITDA margins are very satisfactory and the company has very low debt metrics. On top of that, it pays a dividend. Despite this, Helmerich does not trade at a premium to its peers. Actually it trades at a premium to its book value, but the EV/EBITDA ratio is very low for such a healthy balance sheet.
Helmerich did not stay immune to the weak market of North America. Segment operating income for U.S. land operations was $225,998,000 for Q2 FY 2013, compared with $234,388,000 for Q1 FY 2013. Rig utilization for the company's U.S. land segment remained flat at 82% for Q2 FY 2013, compared with Q1 FY 2013. However, the company's international land operations reported segment operating income of $13,169,000 for Q2 FY 2013, compared with an operating income of $9,111,000 for Q1 FY 2013.
The worst balance sheet among the aforementioned companies belongs to Weatherford International (WFT). The company's margins are decent and the debt ratios are rather high. After all, the current significant premium EV/EBITDA multiple is not justifiable from a fundamental perspective.
In Q1 2013, Weatherford's operating income and margins declined in North America due to the continued oversupply of hydraulic fracturing capacity and the bulk sale of its U.S. guar inventory held at market value. The international division helped the company partly offset its dismal results from North America.
Weatherford expects the second half of 2013 to show modest growth in North America revenues and operating income. Latin America will maintain a steady improvement throughout the year. The outlook for the Eastern Hemisphere remains positive with continued expansion in Europe, Sub-Sahara Africa and Russia, with continued recovery in the Middle East/North Africa and Asia Pacific Region.
Nabors Industries (NBR), Superior Energy Services (SPN) and Oil States International (OIS) are fairly priced. Their financial health lies somewhere in between Helmerich's and Weatherford's financial health. All three of them have good margins and a balanced mix of equity and debt. Nabors could improve its margins if it reduced the outrageous executive compensations, but this issue is out of the scope of this article.
The weak oilfield market in North America took its toll from all these three companies too. Nabors Industries, which owns the world's largest onshore rig fleet, reported a 32% drop in profit in Q1 2013 owing to the worst slowdown in U.S. gas-directed drilling in nearly a decade and a half. Nabors admitted that the near term remains challenging because primarily the North American contract renewal and spot rates remain under pressure across all classes of rigs and all regions. The company also noted that some issues with its international operations are beginning to dissipate and should be gradually extinguished over the intermediate term.
In late February 2013, Superior's CEO noted that the company's annual results reflected lower sequential activity in the U.S. land market area offset by continued strong growth in the international and Gulf of Mexico market areas. In 2012, the company's annual revenue from the international markets and the Gulf of Mexico grew 16% and 12% respectively.
Furthermore, Superior Energy Services does not look to be very optimistic for its U.S.-based operations during the remainder of the year. In Q1 2013 report, the company's CEO commented: "We maintained our prior guidance as the visibility regarding variables driving the range of potential outcomes - specifically the timing and intensity of utilization and rig activity in the U.S. land market areas - is still unknown."
If it was not the activist investor Jana Partners, Oil States International would still hover at ~$80. The stock rose ~25% in May when the activist investor Jana Partners LLC disclosed a 9.1% stake and said it's talked with management about strategic changes. In its Q1 2013 report, the company's CEO stated that the activity in the U.S. operations related to onshore drilling and completion activity was lackluster but this was offset primarily by the company's two acquisitions (Piper Valves and Tempress) that closed in 2012.
After all, I am not bullish for any of the aforementioned companies, because I do not consider any of them to be undervalued at the current levels. To me, they are either richly or fairly valued. I also believe that Weatherford is a good short candidate and I may initiate a short position in this company during the next days.
In my future articles I plan to cover the big onshore players and all the offshore players of this industry. I believe these articles will be a very interesting read primarily for the value investors who want to buy low and sell high. Stay tuned!