Keane: Strong Start To 2018 Despite Q1 Transitory Issues
- Revenue and EBITDA in-line with previous management guidance.
- Transitory issues from extreme cold weather resulted in Q1 results below normalized numbers, issues have dissipated by the end of Q1.
- Expect growth to return during Q2, and forecast next quarter revenue of $555 million to $575 million and adjusted gross profit per fleet of $20 million at exit.
- Reiterate our Buy rating after solid Q1 results and positive Q2 outlook.
We last wrote about Keane (FRAC) on March 7, 2018 and recommended it as our top pick for the U.S. pressure pumping sector. (Our top pick for Canada is Calfrac (OTCPK:CFWFF)). We have since been disappointed by the share price reaction so far, with share price range bound between $15 and $16. However, after the January selloff, the stock has stabilized around current levels despite a rally in oil prices to close to $70 per barrel. We think the industry-wide logistical issues in Q1 are transitory, and investors will eventually realize that Keane and other service stocks are still in for a multi-year bull market for the pressure pumping sector. Investor sentiment will improve if oil price can stabilize above $65, and we believe the market is overly paranoid by the risk of overbuilding. We think the announced newbuilds will be consumed by the growing demand of rising U.S. production and need for refurbishment. Keane is best positioned in the sector due to its strong balance sheet, diversified basin operations with Permian focus, three newbuilds entering service in 2018, and management focus on shareholder return through share buyback.
Q1 2018 Deep Dive
Keane reported first-quarter revenue of $513 million, more than doubling from last year and up 2.3% from last quarter. The industry was plagued by logistical issues and had to cope with bad weather and the resulting delays. Although the market was already expecting a weak first quarter, Keane was able to pull it through and met expectations. The management said that excluding the transitory issues which dissipated as Q1 ended, revenue would have been $530 million, in-line with the initial management guidance. Keane was fully within the range management released with fourth-quarter results which showed the incredible handle of its business by the management.
(Cornerstone and Company Filings)
EBITDA grew to $91 million from $13 million last year. EBITDA was slightly down from last quarter due to the transitory issues discussed above, however, the company expects margin to improve in the coming quarters due to efficiency gains and further pricing increases. We think the market has lowered expectation for 2018 due to the well-known issues across the industry, so the result should be interpreted within that context.
(Cornerstone and Company Filings)
Annualized revenue and gross profit per fleet came in in-line with last quarter, affected primarily by the issues discussed before. We think the second quarter would be a crucial one for Keane to demonstrate its ability to improve profits and support the thesis of a tightening fracking market.
(Cornerstone and Company Filings)
Keane previously announced 150,000 HHP of newbuild representing three new fracking fleets in December 2017. The first fleet will be deployed by late May in the Marcellus/Utica basin and the second fleet will be deployed in the Permian, bringing the total number of fleets in service to 28 by the end of second quarter. Keane also expects to announce a dedicated agreement for its third fleet soon. Management previously expected the third fleet to be delivered by Q3. Management expects annualized gross profit per fleet of $20 million for each of the first two fleets, which represent material organic growth opportunities going forward. We think Keane has capitalized on the growing U.S. pressure pumping market by timing its newbuild order early so it could hit the market during this optimal time (lead time for newbuild order is getting longer). We are confident that the management will be able to secure a commitment for its third fleet under similar if not better economics, thereby adding a total $60 million in adjusted gross profit.
Management guided the second-quarter revenue in the range of $555 million to $575 million as transitory issues disappeared at the end of Q1. The first of the three newbuilds is also expected to enter service by late May. Adjusted gross profit per fleet is expected to exit the second quarter around $20 million, up from $17 million this quarter. Keane expects the current full utilization to continue in the second quarter, including the first two newbuilds entering service during the quarter. Keane will continue to utilize its share repurchase program which has an authorization of up to $100 million through 2018. Keane is one of the first in the industry to start returning capital through share repurchases. The move is supported by strong growth, conservative balance sheet, and excess cash flow. We are encouraged by its shareholder-friendly strategy and look forward to seeing more companies follow the lead.
Keane reported first-quarter results well in-line with management's previous guidance including the transitory issues that was well-understood across the industry. The guidance for second quarter calls for another strong period of organic growth driven by pricing and efficiency gains, further complemented by the delivery of two newbuild fleets. We think the shares are attractively valued given the growth potential and cash flow generation. We think investors should position themselves for the bull market in the pressure pumping sector that is going to last at least for the next couple of years. The service sector has taken the time during the last downturn to improve efficiency and the pace of newbuild will be more than absorbed by the unmet demand and need for refurbishment. We believe the sector will stay undersupplied through 2018 which could lead to full utilization for Keane's existing and newbuild fleets for the next 12 months. We are encouraged by the first-quarter results and think Keane is off to a strong start to a crucial year in 2018.
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