Patterson-UTI (PTEN) continued its strong momentum from the last quarter, further increasing earnings from their drilling segment. Rig backlog increased as well, but pressure pumping weakened. While completions slowed due to exhausted budgets and takeaway capacity, DUCs (drilled but uncompleted wells) saw a rise since drilling has increased in order to set the table for 2019, when completions resume.
PTEN should be rewarded for their efforts to grow drilling revenues during challenging times. These developments also bode well for DUC counts, and should provide PTEN's pressure pumping segment with a boost in 2019. The new megatrend of zipper fracs moving to the Permian on a larger scale will also require more completion crews. So, as a result of all revenue segments having major catalysts to grow revenues in 2019, now is the time for investors to position themselves for the upturn in Patterson-UTI.
Drilling Segment Success Is The Dominant Theme
Patterson's rig count averaged 178 rigs in the second quarter, which grew by 2 rigs from the prior quarter. Super-spec rig demand remains high as laterals and intensity are growing, and so day rates increased by $410 to $22,280. In total, margin per day per rig stood at $8,470. PTEN's rig count should grow by 4 to 182 rigs next quarter, and day rates are expected to rise in tandem by $500.
So, while completions activity may be slowing, drilling is actually increasing in the U.S. This could mean, perhaps, that E&Ps are building their DUC inventories up for 2019, when new budgets are reset with higher oil prices, and additional takeaway capacity comes online. If more DUCs are added to E&P inventories, PTEN's completion segment should have no trouble filling white spaces on their calendars.
Whether completions resume in a timely fashion or not, PTEN's drilling and rig divisions should see continued strength. The need for precision placement of these extended laterals are too great these days since the costs savings can be tremendous (as fixed costs get leveraged through larger jobs). Consequently, new super-spec rigs equipped with the technology required should see steady orders.
Their backlog is already growing to confirm this trend. New contracts added $825 million to day rate drilling revenue, which was a 20% increase compared to the previous quarter. Patterson-UTI already has 145 super-spec rigs out of the 625 super-spec rigs currently available in the U.S., which makes them a market leader. So, PTEN's market share should grow as well, especially since there are 53 APEX rigs left that can be upgraded to super-spec capabilities.
New Megatrend: Zipper fracs Are Moving To The Permian
Zipper fracs are a common completion technique used mostly in northern basins where two wells are fracked simultaneously at alternating stages (which resembles a zipper). But, Patterson-UTI gave investors a nugget from their recent conference call. They said that zipper fracs are quickly becoming adopted in the Permian now, as opposed to being predominantly used in the north.
This was a significant point because almost 50% of all drilling and completion activity happens in the Permian. So, if zipper fracs are used in a larger scale, more drilling and completion services will be needed, which will accelerate earnings growth for companies like PTEN.
Put more precisely, zipper fracs are a continuous pumping operation. Therefore, they will need more horsepower per spread for completion jobs, which bodes well for supply/demand dynamics in pressure pumping. On the Q3 2018 call, management said:
I think when you look at it from an industry standpoint, as Permian increases the amount of zippers they're doing, it does require us as an industry to increase the amount of horsepower per spread.
Needless to say, zipper fracs moving to the Permian will be a huge tailwind for the services industry, especially PTEN.
PTEN Reduced Spreads As Pressure Pumping Weakened
It has been widely-known that pressure pumpers would struggle in the third quarter. When Keane (FRAC) announced their reduction in guidance mid-way through the previous quarter, the levy broke. Numerous service companies came out after FRAC reporting delays in completions, idling of plants, and reductions in pressure pumping crews.
So, when PTEN announced third quarter earnings, it came as no surprise when they decided to idle their fleets. PTEN dropped from 25 to 21 marketed spreads, and consolidated remaining jobs across those spreads. Some of this work came from spot opportunities, which can occur when there is downtime from contracted fleets. In other words, the spot market is helping to fill white spaces on PTEN's calendar in a time when jobs are difficult to come by.
Even with a challenging market, those spot market opportunities caused revenues to fall by only $3 million to $422 million quarter-over-quarter. Gross profit was stronger than expected, as well, coming in at $79.1 million, which was down from $82.4 million in the previous quarter.
Despite the slowdown, PTEN believes issues are transitory (like most other services players) and expects completions activity to resume in 2019 due to E&P's budgets being reset at higher oil prices, and takeaway capacity finally coming online.
Increased rig activity (stated above) is also driving more DUCs. In fact, the DUC count increased 25% in the third quarter, and PTEN expects these wells to be completed early in 2019 in order for E&Ps to take advantage of higher oil prices. Here is more on what PTEN had to say about DUC counts:
We really feel like there is going to be an acceleration in the inventory of the drilled but uncompleted wells in the fourth quarter and going into the start of 2019.We do have some customers that say that they are going to be starting in early 2019 on the completion side right after the year starts and the budgets reset. So, we're already getting some of that discussion with some of the customers.
So, when pipelines, budgets, and DUCs are completed, pressure pumping demand will cause the need for new spreads and horsepower to be added quickly, which should accelerate Patterson-UTI's revenue growth earlier than expected in 2019.
Patterson-UTI reported a loss last quarter, but issues were transitory. Despite the slowdown in completions being temporary, there were many other developments on their conference call to be upbeat about.
PTEN's drilling segment remained strong, and actually added more DUCs during the downtime in their completions segment. These moves in drilling, coincidentally, will actually add more business to PTEN's completions segment when E&P activity resumes. Also, the mega-trend announced by PTEN that zipper fracs are moving to the Permian should provide more business to their completions segment than previously thought, which should contribute to significantly to PTEN's bottom-line.
Increased drilling activity, DUCs, and zipper fracs in the Permian should all act as favorable catalysts for PTEN going forward. So, since the company's recent stock price woes are expected to be short-lived, investors should position themselves accordingly for the next upturn, as a favorable risk/reward opportunity from the recent market sell-off is now presenting itself in Patterson-UTI.
Disclosure: I am/we are long GUSH.
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.