RES Is Still Under Pressure
RPC, Inc. (RES) provides specialized oilfield services and equipment primarily to the E&P producers in the U.S. and the international markets. Considering the challenges currently faced by the oilfield servicing companies, I do not think the stock will produce positive returns in the short-to-medium term. The excess supply of the pressure pumping equipment and the upstream capex spend decline will continue to affect hydraulic fracturing activity, which is likely to keep the pricing for pressure pumping services depressed in the near-term. The lack of visibility into upstream operators' capex is a significant obstacle to the company's growth prospect.
However, the crude oil price rise in Q1 and the increase in the DUC wells signal an anticipated surge in the completions activities in 2019. RES may add a pressure pumping fleets and a few coiled tubing units in Q2. While the addition to the pressure pumping unit may not be accretive to the top line or margin, the introduction of the large coiled tubing units may lead to market share gains for the company. But there needs to be a sustained recovery in the industry to produce considerable positive returns from the stock.
RES' Fundamental Drivers
The 2014-16 energy price depression has brought out the critical issue of choice between pricing and asset utilization for the energy servicing companies, especially the smaller ones. Excess capacity in the OFS industry depressed the pricing over the past couple of years. On top of that, a rising labor cost was exerting pressure on the margin. In response to this, RPC restricted the size of its fleet of revenue-producing equipment. The trend has continued at least until January of this year, as the company let some of its assets go under-utilized because of the lack of pricing that would make economic sense. On a more encouraging development, the rate of decline in its pricing did come down in Q1, as the crude oil price recovered in Q1 after a choppy Q4 2018. In Q1, the West Texas Intermediate (or WTI) crude oil price went up by 32% after it had fallen by 38% in Q4. Higher crude oil price, if sustained, can result in higher upstream activity, which can lead to higher asset utilization and better pricing for the OFS companies like RES.
The company's revenues started declining again since Q3 2018. From Q4 2018 to Q1 2019, revenues decreased by 11%, while operating profit crashed during the period. In Q1, it recorded $2.2 million operating loss in contrast to $19.6 million operating profit a quarter ago. The upstream companies' capex budget reduced in Q1, which put pressure on the company's revenues and margin.
A Segment-Wise Driver Analysis
Segment-wise, RES' Technical Services revenues decreased by 12% in Q1 2019 compared to Q4 2018. Through this segment, the company offers pressure pumping to downhole tools, snubbing, well control, coiled tubing, wireline, and fishing equipment. The primary negative drivers were the lower pricing and lower activity in pressure pumping. Lower pricing not only affected the top line, but it turned the Q4 segment operating profit to a $4.5 million loss. The Technical Services segment accounted for 94% of the company's Q1 2019 revenues.
Revenues from the Support Services segment were resilient, increasing by 4% from Q4 to Q1 2019. Also, in contrast to the Technical Services segment, operating profit in this segment increased by 24% in Q1 compared to the previous quarter. The growth resulted from higher activity levels in many of the service lines within this segment. Though this segment, the company offers rental of tubular and related tools, inspection and storage services, and pipe handling services. Pressure pumping and ThruTubing Solutions were the two highest revenue earners for the company in Q1 (44.2% and 32.8%, respectively).
A Discussion On Costs
RES' cost of revenues was on the rise in Q1 2019. Its cost of sales as a percentage of revenues increased to 75% in Q1 compared to 73% a quarter ago due to the sticky nature of labor costs in the short-term. But a reduction in other variable costs offset some of the pressure on the company's margin. Weaker activity in pressure pumping also led to lower cost of materials and supplies, while sand costs also reduced in Q1. So, even though the overall effect of lower pressure pumping demand was a dent on the margin, the result was somewhat nullified by lower operating costs.
Will The Industry Drivers Affect RES' Outlook In Q2 2019?
Now, the real question is what's the outlook for Q2, and to what extent the company can manage the weakness in the industry. Well, the company's management is cautiously optimistic given the relatively stable pressure pumping activity level in March 2019. The growth in the completed wells (4% up) and DUC (drilled but uncompleted) wells (17% up) far exceeded the drilled wells (2% down) in the key U.S. unconventional energy resources in the first quarter in 2019. The rise in the DUCs can pave the way for a faster recovery in the completions activities, provided the crude oil price stays steady. However, many OFS companies in the industry are still not convinced of a completions activity revival in North America. For example, TechnipFMC (FTI) inferred in the Q1 2019 earnings call that onshore operations will continue to face headwinds in the U.S. completions activities, which will lead to the idling of pressure pumping assets or removing assets from its fleet.
The lack of new drilling also suggests that pricing pressure is likely to continue. The exploration and production activity has not seen any adequate turnaround, because the upstream producers are looking to reduce their capex. As a result, the company's management is not overly optimistic of a turnaround. Here is what the management commented in the Q1 earnings call:
Going forward, at this point, the March exiting run rate would tell you that the second quarter looks better. March was the best month of the quarter measurably. But we have very little visibility right now. So a number of our customers have engaged us to do things and had jobs slowdowns for various reasons. So we just don't have a lot of - we don't have a lot of visibility, so things look better in the second quarter, but real lack of visibility at this time.
So, RES' near-term market opportunities lie in moderately higher oil prices and resolution of the Permian Basin takeaway capacity concerns. In both Q4 2018 and Q1 2019, its active pressure pumping fleet count was 16. The company estimates that it will add one pump to its fleet in Q2. Beyond that, once again, the outlook is shrouded with uncertainty as the upstream capex is set to fall in 2019. Approximately 70% of the company's active pressures pumping units are dedicated. While the advantage of the dedicated units lies in better utilization plans and logistics, the benefits of an increase in spot prices get forfeited in that arrangement.
The company may also add a few coiled tubing units in 2019, which would be used in long link collateral completions. Increased sales of the large diameter coiled tubing units are expected to increase the company's market share in this business. Although there can be less demand for the ThruTubing units due to the spring break up in Canada, increased activity in the completions market in the U.S., as I discussed earlier in the article, will drive revenues.
Dividend And Repurchase
In April 2019, RES reduced the quarterly dividend by half to $0.05, or $0.20 annualized. Its forward dividend yield is 1.95%. The company's rationale behind slashing the dividend was to strengthen its capital structure and to maintain a conservative balance sheet. In February 2018, RES increased the number of shares authorized for repurchase by 10 million shares.
Net Debt Is Negative
RES' net debt was negative as of March 31 as a result of zero debt but positive cash & cash equivalents balance ($113 million) as of March 31. Being a debt-free company is one of the company's prominent features, because when energy price nose-dives, earnings dip, and servicing of debt become difficult. In that scenario, the company would be better equipped to survive compared to many of its OFS industry peers. Its peers National Oilwell Varco's (NOV) net debt stood at $1.3 billion as of March 31, while Precision Drilling Systems' (PDS) net debt was $1.6 billion as of March 31, 2019.
What Does The Relative Valuation Say?
RPC, Inc. is currently trading at an EV-to-adjusted EBITDA multiple of 6.7x. Based on sell-side analysts' EBITDA estimates, the forward EV/EBITDA multiple is 8.0x. The current EV/EBITDA multiple is lower than its past six-year average of 8.8x.
RES' forward EV-to-EBITDA multiple expansion versus the adjusted trailing 12-month EV/EBITDA is in stark contrast to the industry peers' average multiple compression, because the sell-side analysts expect its EBITDA to decline compared to a rise in peers' average in the next four quarters, which would typically result in a lower current EV/EBITDA multiple compared to the peers' average. The company's EV/EBITDA multiple is lower than its peers' (PUMP, NR, and LBRT) average of 6.3x. I have used sell-side analysts' estimates provided by Thomson Reuters in this analysis.
According to data provided by Seeking Alpha, four sell-side analysts rated RES a "buy" in April (including strong buys), while 13 of them rated it a "hold". Seven sell-side analysts rated a "sell". The consensus target price is $10.9, which at the current price yields 5.3% returns.
What's The Take On RES?
While the crude oil price made a comeback in Q1 after a depressing final quarter in 2018, the rise in the DUC wells signals an anticipated increase in completions activity in 2019. However, the excess supply of the pressure pumping equipment and the upstream capex decline will continue to affect the hydraulic fracturing activity, which is likely to keep the pricing for pressure pumping services depressed in the near-term. The lack of visibility into upstream operators' capex is a significant obstacle to the company's outlook.
In this backdrop, RES has a challenging choice to make between sales volume growth and margin protection. The company may add a pressure pumping fleet and a few coiled tubing units in Q2. While the addition to the pressure pumping unit may not be accretive to the margin, the introduction of the large coiled tubing units may lead to market share gains for the company.
I do not think RES will be able to turn around in the short-to-medium term. However, RES is a debt-free company. This feature can improve RES' relative valuation if the crude oil price weakens and the energy sector heads into another crisis.
The Daily Drilling Report
We hope you have enjoyed this Free article from the Daily Drilling Report Marketplace service. If you have been thinking about subscribing after reading past articles, it may be time for you to act.
Good news for new subscribers! In May we are offering a 10% discount off the annual subscription rate of $595.00
Give it some thought, and act soon if you are interested. A 2-week free trial is applicable, so you risk nothing. Hope to see you in the DDR as we look for bargains in the oil patch!
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.