Calfrac: Q2 2018 Solid But Guidance Gives Concern

Summary

• 2018 Q2 results beat estimates on higher revenue and margin.
• Management gave a cautious outlook for the second half of 2018.
• Near-term outlook is clouded due to sector-wide pessimism but we continue to favor Calfrac as the best name in the sector.

When we published our analysis for 2018 Q1, we were seeing a strong start to 2018 from Calfrac (OTCPK:CFWFF) that included a major rebound in the U.S. business and upbeat guidance from management who dismissed the overbuild concern. However, despite the strong results, management turned cautious on the U.S. outlook for the second half of 2018 due to concerns of Permian bottleneck and oversupply in the fracturing industry. The stock turned lower sharply following the guidance that 3 of the U.S. fleets will not be fully utilized in the Q3 and Q4 this year, leading to concerns that margins have peaked during Q2. Management has not helped by citing concerns over any further pricing gains and uncertainty for maintaining its current utilization. We think Calfrac's problem is definitely not unique as we have been hearing cautious tone across all major fracturing providers. However, the stock is at a juncture where if overbuild concern materials we could see Q2 as the peak profitability for a while, however, the industry might also prove to be a lot more resilient and is able to adjust and absorb the additional capacities entering the market. We tend to favor the second view and continue to hold a position in Calfrac due to its unique torque to a recovery in fracturing demand.

(Source: Bloomberg)

2018 Q2 Quarter Review

Calfrac reported another strong quarter with revenue growing 67% from last year. However, gross profit margin slipped from 12% to 10%. The company is coming off a trough year in 2017 and investors are focusing on 2018 as a baseline year for the near future. Pressure pumping peers have mostly reported decent Q2 results but management has expressed various levels of concerns regarding the state of the fracturing market. Investors are getting concerned about the Permian pipeline shortages and the impact on fracturing demand. The one million of HHP that Schlumberger (SLB) is planning to put into the market will create additional pressure on pricing and utilization.

EBITDA for the second quarter came in above our expectation and more than doubled from last year. Margin also stayed healthy at 15% which rebounded from the previous two quarters. The quarter by itself is a strong quarter but the problem is the guidance that management provided.

Canada continues to chug along while outlook remains weak for the near-term. Gas prices remain depressed in Western Canada and higher oil prices have not translated into an uptick in E&P spending. We see limited opportunities for the Canadian operations to turn around anytime soon.

The U.S. remains Calfrac's best hope and its crown jewel. No wonder the Wilks brothers are eying this part of the business and pushing for a spin-off or sale of the U.S. segment by Calfrac. Despite a blowout quarter from this segment, management expressed concerns for the second half outlook which we will discuss in more details below.

Why the Stock Dropped?

On the surface, the second quarter was a very strong one for Calfrac with revenue and EBITDA both coming in above our expectations. However, the problem here is the management's outlook for the second half of the year that gave concerns about the sustainability of its current profitability. First of all, management noted that three of its U.S. fleets will not be fully utilized during the third quarter and beyond due to softness in the market. Clearly, some clients are putting off or delaying fracturing work in the Permian region due to pipeline capacity concerns and Calfrac is seeing the impact immediately due to its nascent presence in the basin. On the other hand, Calfrac also has limited to Permian given the majority of its fleet is located in other basins. If the Permian situation gets worse, fracturing companies will move capacities out of Permian and compete with Calfrac in other regions which will then impact pricing and utilization across the market. For the U.S. business, management guided Q3 to be roughly in-line on the top-line as the 17th fleet enters service but utilization will drop for some of the crews. Management also cited concerns over their ability to increase pricing in the near-term.

Overall, investors did not get a confidence boost from Calfrac management regarding the second half outlook this year. The guidance for flat revenue despite one more fleet entering service basically means lower margin per fleet and higher maintenance expenditures. We still Calfrac represents the most attractive investment in the North America onshore sector due to its leverage to higher fracturing demand and leveraged balance sheet. The recent refinancing has pushed out its debt maturity and removed the second lien tranche, paving ways for the company to further reduce debt from asset sales and free cash flow. We have taken the opportunity to trim our position significantly during the May rally but continue to hold positions in this stock.

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Analyst’s Disclosure: I am/we are long CFWFF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.