NINE Does Not Have Strong Impetus Yet
Nine Energy Service (NINE) is a North American onshore completion and production services provider. I do not expect the stock price to show positive momentum in the short term. The upstream operators are likely to reduce capex budget in 2019, which will not augur well with NINE’s revenue and margin growth prospect. There are strong headwinds in the small-diameter coiled tubing units, which can affect the company’s margin adversely in Q2. However, a steadying margin could improve returns from this stock in the medium to long term.
Despite the headwinds, the technological advancement through the acquisitions of Frac Technology and Magnum are expected to fuel growth in the coming quarters. Market share gains in the Permian, Delaware and Midland Basins in the cementing business also benefit the company. Its competitive advantage lies in offering differentiated products like the dissolvable frac plugs and casing flotation tools, which are expected to keep the margin steady. The company has a long way to go before it achieves its net-debt-to-EBITDA ratio target (lowering debt versus any potential asset sale).
Positive Drivers: Dissolvable Plugs And Casing Tools
During Q1, the well intervention activity was resilient, which led to a steady demand for frac plugs to isolate stages during plug and perf operations. The company is working on designing the shorter composite and dissolvable plug designs. Also, due to the cold formations in the US, particularly in the Permian, we can expect volume increases of dissolvable plugs. Also, there have not been many new entrants in the market because of high entry barriers. So, NINE has a big opportunity to advance its market share gains in this line of product.
Although competition is high in the fully-composite and dissolvable frac plugs product market, it was able to moderate the declines in the average selling price by introducing new and differentiated products. When the bottom hole temperature varies, the performance of the polymer used in these plugs gets affected. The company aims to refine its high and low-temperature frac plugs and expects to make these ready for commercialization by 2020.
Apart from that, the company’s casing flotation tool sales increased by 80% in Q1 compared to Q4 2018. So, the casing flotation too is gaining market share across the US and Canada. It also believes that despite any short-term weakness in the crude oil price, the benefits of using the dissolvable plugs will drive demand.
Opportunities And Concerns
In Q1 2019, Nine Energy Service’s top line remained unchanged compared to Q4 2018. On a year-over-year basis, however, its revenue increased by 32% in Q1 2019. The company’s cementing business was one of the key growth drivers in Q1. Here, high-grade cement and water are blended with various solid and liquid additives, which creates cement slurry. The slurry is then pumped between the casing and the wellbore. Quarter over quarter, the cementing business increased by 10% in Q1 2019. Much of the company’s market share gains in the cementing division took place in the Permian, Delaware, and Midland Basins through the combination of slurry development and execution at the well site. In Delaware, the company introduced a new cost-effective cement blend. Also, the company is working with one of its customers in the Mid-con for a greenfield expansion and expects to make the facility operational by the end of 2019.
The Coiled Tubing unit, which is another significant part of the Completion Solutions segment, saw increased activity in Q1. NINE grew higher market share of stages completed from 18% in the previous quarter to 20% in Q1 2019. However, the coiled tubing business ran into some trouble during the quarter. While the demand for the large diameter units remained consistent, the utilization and pricing for the smaller diameter unit were down. Lower demand for smaller diameter units led to lower sales.
Analyzing The Q1 2019 Segment Performance
As a result of the performance of the divisions as described above, NINE’s Completion Solutions segment revenues, which accounted for 93% of the Q1 revenues, remained unchanged compared to Q4 2018. The segment adjusted gross margin deflated to 22.8% from 26.4% earlier. Increases in the cost of services exceeded the rise in revenues following the Magnum acquisition in Q4 2018 as well as increased costs in other service lines within the segment.
Revenue growth is NINE’s Productions Solutions was also muted in Q1. However, the segment gross margin inflated to 16.6% from 13.6% a quarter ago. The cost of services was affected by the decrease in expenses related to materials consumed while performing services. The rig fleet utilization and total rig hours remained unchanged during this period. Among the other key metrics, there were a few encouraging signs, including a 1% rise in the average revenue per rig hour.
What’s The Industry Outlook?
While the 2019 upstream capex will decline compared to 2018 and the energy price is looking to stay volatile, NINE’s management did sound reassured by the pricing stabilization and consistency in the overall upstream activity. According to its management estimates, if the West Texas Intermediate (or WTI) crude oil price stays above $60, many independent upstream operators will increase activity, which can provide traction to NINE’s pricing of its offerings.
Given the industry outlook, NINE will look to grow its revenues organically, while also evaluating the acquisition options across the existing service lines and geographies based on satisfactory returns and cash flows. In particular, the Magnum (acquired in October 2018) and Frac Tech (also acquired in October 2018) are adding to the company’s operational and capital efficiencies gains due to their reach in the multi-well pad and large scale developments.
What’s The Segment Outlook?
The company’s completion tools sales can increase while pricing for wireline can remain flat in Q2. In coiled tubing, the company’s operating margin can remain steady despite the pricing concession. Pricing, however, can improve in Q3 and Q4 of 2019, if the crude oil price stabilizes. NINE, over the past quarters, has kept its pricing steady in its service lines unlike the completions side of the business. So, margin of the service lines can be expected to stay resilient in Q2.
The other interesting aspect concerns the spread in day rates between large diameter and small diameter coils. Due to low demand in the unconventional shales, NINE has reduced the mix of small-diameter coiled tubes and increased the production of larger-coiled tubes.
So, in Q2, the company is expected to generate total revenues in the range of $230 million to $240 million. At the guidance midpoint, it represents ~2% rise compared to Q1. In Q2, the EBITDA of $38 million to $42 million at the guidance midpoint would remain flat compared to Q1.
What’s The Current Financial State?
In association with the Magnum Oil Tools acquisition, NINE issued $400 million of debt which would be due for repayment in 2023. As of March 31, 2019, it had $161 million in liquidity. Earlier, in the Q4 earnings conference call, the company discussed its aim to achieve target leverage of 1x net debt-to-EBITDA, which is significantly lower than its current indebtedness.
Compared to NINE’s debt-to-equity ratio of 0.47x, Nabors Industries’ (NBR) debt-to-equity stands at 1.3x, ProPetro’s (PUMP) debt-to-equity stands at 0.16x, and Oil States International’s (OIS) debt-to-equity is 3.0x.
Since it has no debt repayment before 2023, its balance sheet is relatively free of any near-term financial risks. Even with deleveraging, there are not many drivers for the company to achieve robust operating earnings growth, and this can render the target challenging to achieve in the short term.
In Q1 2019, NINE’s cash flow from operations was $5.9 million and decreased by 66% from a year ago. Despite a 32% rise in revenues during this period, the company’s working capital requirement increased in Q1 2019, leading to the fall in CFO. The company plans to spend $60 million to $70 million in capex in FY2019, which would be ~18% higher than its FY2018 capex. Although the company has sufficient liquidity to fund higher capex, it might want to improve cash flows to avoid further strains on the balance sheet.
What Does The Relative Valuation Imply?
NINE is currently trading at an EV-to-adjusted EBITDA multiple of ~7.2x. Based on sell-side analysts’ estimates, the forward EV/EBITDA multiple compression implies higher EBITDA. The stock is currently trading at a discount to its past three-quarter average of 14.7x.
NINE’s EBITDA is expected to increase more sharply than the rise in the peers’ average in the next four quarters, which typically results in higher EV/EBITDA multiple compared to the peers. The company’s EV/EBITDA multiple is higher than its peers’ (NBR, PUMP, and OIS) average of 5.2x. I have used estimates provided by Thomson Reuters in this analysis.
According to data provided by Seeking Alpha, eight sell-side analysts rated NINE a “buy” in June (includes “outperform”). None of the analysts rated it a “hold” or a “sell”. The consensus target price is $28.5, which at the current price yields 71% returns.
However, according to Seeking Alpha’s Quant Rating, the stock receives a “Very Bearish” rating. Although its rating is moderate on growth, the ratings are poor on value, profitability, EPS revisions, and momentum.
What’s The Take On NINE?
The upstream operators are lowering their capex budget in 2019, which will not augur well with the NINE revenue and margin growth prospect. There are strong headwinds in the small diameter coiled tubing units, which can affect the company’s margin adversely in Q2.
NINE’s technological advancement through Frac Technology and Magnum Oil acquisitions are expected to fuel growth in the coming quarters. The company’s market share gains in the Permian, Delaware, and Midland Basins in the cementing business also benefit the company. Its competitive advantage lies in offering products like the dissolvable frac plugs and casing flotation tools. Despite the lack of strong demand, its margin is expected to remain steady due to the offering differentiated products. Given the headwinds on the top and bottom line, it will not be easy for the company to achieve the net-debt-to-EBITDA ratio target (lowering debt versus any potential asset sale). I do not expect the stock price to show positive momentum in the short term. However, a steadying margin could improve returns from this stock in the medium to long term.
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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.