RPC (RES) is currently taking a hit as investors digest Q4 results. Despite drastically failing to meet expectations, we believe the long-term picture remains intact. Notes from quarterly call:
The revenue line was better than we forecasted, however, the cost of revenue came through $21mil higher and was the primary reason for the bottom-line miss. Our higher cost takeaways:
1. Rolling off the last contract on Oct. 1st and placing those services into the spot market. We believe this contract was much larger than expected and the gap between the contract price and spot price was also larger than expected, creating a double whammy.
(This is a one-time occurrence)
2. Management cited higher end proppants (ceramic and resin coated sand) used on a new job as a drag on margins. The higher material cost was unable to be passed through.
(Management believes to have identified a few areas to fix this issue as it is customer specific)
3. Management also cited supply expense and logistical issues. There was commentary on customer rotation that seems to have come out of Haynesville and into the Permian; as Haynesville dropped to 5% of the fleet and the Permian jumped up to 43%-45%. There is a high cost to move equipment from one location to another; and further commentary suggests new vendors were used at new locations, thus possibly creating material pricing and delay issues.
(We believe this is an ongoing cost of doing business in a choppy environment, though Q4 may have been impacted a bit harder than normal)
4. Higher activity forced labor costs up, which were not passed along due to competitive pricing issues.
(We believe this drawback should continue until spot pricing moves higher)
-Spot markets did not decline… two quarters in a row that mgmt. has stated more stability
-Raw materials decreased, further suggesting above issues were customer specific.
-Utilization was actually higher due to activity and job intensity.
-Mgmt. has not seen any new horsepower come online.
-Firming gas prices and potential increased activity in Marcellus/Utica
Management still sees a bright future, "We are very -- we feel very good about the long-term. I think there is excitement about potential for 14 and, certainly, with the continued industry trends that we talked about with the longer laterals and greater service intensity."
Mgmt. stated Q4 margins as an outlier and Q3 margins at the high end of their cautious view on run rate, suggesting Q1 margins may fall in between.
Mgmt. outlook for Q1 revenue was a possible 5%-7% sequentially higher, but on any continued choppiness may be flat to slightly up.
-suggesting a Q1 range of revenue would be from $487mm-$521mm; mid-point EBITDA margins near 26.3%
Given the new information and despite Q4 cost issues we believe our prior thesis remains intact. The majority of positive operating results should not come until late spring and last through what we expect to be a better 2H2014. We reiterate a buy and stick to a $23 PT, though offer a low case target $20.50 in the case of any Q4 issues persisting past Q1. We especially like RES if trading levels are able to hold the $17-$17.50 area on a closing basis.