Key Energy Services (KEG) calls itself "the largest onshore, rig-based well servicing contractor based on the number of rigs owned" in the company's most recent 10-K. As a companion to an article I wrote recently about Basic Energy Services (BAS), I want to explain why difficult industry conditions, poor financial results and a problematic debt load means trouble on the horizon for Key.
1. The state of oilfield services is dismal
Onshore oilfield services is one of the most distressed sector in America today. Most prominently, large service provider Weatherford filed for bankruptcy several weeks ago, wiping out over $5 billion in debt. Large competitors with offshore and onshore divisions that remain profitable such as Schlumberger (SLB) are trading at prices far lower than they were at the depths of the oil price crash of 2016. This article describes a study from industry analysts at Rystad projecting that oilfield services may not recover until 2023!
News is similarly bad at Key's competitors such as Pioneer Energy Services (PES). Since reporting earnings on May 2, Pioneer's bonds maturing in 2022 have fallen in price from over 70 cents on the dollar to 47 cents yesterday. In the seventies with a 6% coupon, these bonds had a yield-to-maturity of over 15%, which balanced the prospects of some returns against a meaningful prospect for default. At under 50 cents, the seller of the bonds probably believes the company will default and he will see a significant loss of principal. Pioneer's stock prices is down 75% over the same time as well.
2. Key's Financial Results
Since emerging from bankruptcy in December of 2106, Key has lost money in every quarter of 2017 and 2018, as can be seen from the following table in Key's 2018 form 10-K:
According the most recent 10-Q, Key lost another $23 million in the first quarter for a total retained deficit of $243 million.
Oil well-services comprises a number of different product lines, and Key provides segment information for four operating segments and general overhead. This table is taken from the most recent 10-Q:
As you can see from the "Income (loss) before income taxes" line, Key's net loss of $23 million last quarter consisted of $24.7 million of net loss in the "functional support" segment, which included more than $9 million of interest and $16 million in operating losses for corporate overhead. The rest of the business lines essentially broke even. Page 20 of the quarterly report also contains two charts showing the quarterly average oil and gas prices and the industry-wide rig count numbers for each of the last five quarters.
For the first three quarters of 2018, oil prices were in the mid-60s and gas prices averaged almost three dollars. At no time for the first three quarters of 2018 was Key profitable. It only stands to reason that for the second quarter of 2019, when WTI prices averaged $60 per barrel and gas prices have been lower than at any time in 2018, we can expect drilling activity to be reduced and pricing pressure to persist. For these reasons, I expect Key to post a second quarter loss of $20-$25 million - for the tenth quarter in a row.
3. Debt problems on the horizon
As described on page s 38 and 39 of the annual report, Key owes $250 million in bank term loans. On page 13 of the most recent 10-Q, Key explained that they pay 13% interest on this debt. As we've seen above, half of Key's recurring losses are due to these substantial interest payments.
The term loan requires Key to maintain minimum liquidity of $37.5 million as of the last day of every quarter (see Annual Report, page 85). In Key's earnings release from the first quarter, they company reported, "As of March 31, 2019, Key had total liquidity of $57.3 million, consisting of $35.7 million in unrestricted cash and $21.6 million of borrowing capacity available under the Company’s $100.0 million asset-based loan facility. This compares to total liquidity at December 31, 2018 of $74.3 million [...]."
These numbers should give investors cause for alarm. As of March 31, Key was less than $20 million over its minimum liquidity covenant, and had lost $17 million in liquidity the previous quarter. It is clear that under current operating conditions there is a substantial risk they will be in violation of the covenant this quarter! For what it's worth, in my experience companies have a lot of opportunities to do things such as delay paying certain bills and undertaking expenses until after the end of a difficult quarter, so I don't expect Key to report that they're in violation. But that give no room for comfort - it only means that this problem should be unavoidable in another quarter. Let it also not go unsaid that the banks have the ability to reduce the covenant the requirement to avoid a covenant violation, but this doesn't mean things are OK at the company - it just means the lenders prefer to "extend and pretend" than foreclose or take action on an impaired loan. As we saw with Orchids Paper Products last year, Orchids' lenders continued extending credit for over a year to a company that had stopped making any payments at all on its loans before ultimately filing for bankruptcy.
4. Recent Trading Activity Does Not Reflect Fundamentals
On June 28, Key received a notice from the New York Stock Exchange that it's market cap had fallen below the required $50 million minimum. Shortly after, the stock began gaining in price from as low as $1.60 per share to as high as $3.00 last week. At the same time, the cost to borrow shares to sell short went as high as 97.5%. To some degree, this is understandable because 75% of Key's shares are owned by four holders, including on group who owns more than 50% according to the most recent proxy filing. While a low public float may make Key hard to trade, it does not change the results at the underlying business. I anticipate the shares being traded in such a way that the stock maintains a market cap above $50 million for 30 days, and then comes back down.
For the reasons stated above, I believe Key will continue to lose money through the second quarter with no signs of improvement in the foreseeable future. With a difficult industry backdrop and a crushing debt load, the prospects for equity holders are bleak. I expect Key's shares to trade down below $1.50 per share within the next three months, and I am short accordingly.
Disclosure: I am/we are short KEG. 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.