Superior Energy Services’ (SPN) offerings include drilling products and services, onshore completion and workover services, production services, and technical solutions. I do not think the company can produce positive returns in the short-term. In the medium-to-long-term, until it deleverages its balance sheet, I will not recommend buying into the stock.
The pricing pressure and lower pressure pumping utilization in North America has forced Superior Energy to reduce fleet size and divest the drilling rigs service line in Q2. To boost sales and margin, it has been concentrating on improving its international operations. The project in Kuwait, expected to come up in 2H 2019, would boost revenues. Also, a resurgent offshore market can improve the company’s outlook in North America. More importantly, it needs to boost cash flows and/or sell assets to deleverage the balance sheet. Until that happens, investment in the stock involves a significant risk factor.
On average, the West Texas Intermediate (or WTI) crude oil price witnessed a 9% rise in Q2 2019 compared to the average WTI price in Q1. Despite that, the fall in the DUC (drilled but uncompleted) wells and drilled wells (both 3% down) far exceeded the completed wells decline (1% down) in the key U.S. unconventional energy resources in June compared to March. The fall in the DUCs indicates a slower recovery in the completions activities, while the lack of new drilling also suggests that the pricing pressure continues. Also, the exploration and production activity has not seen any adequate turnaround, because the upstream producers are reducing their capex spend.
The constraints in the upstream investment would affect the OFS companies’ growth adversely in 2019. With the excess supply of pressure pumping equipment in the market, prices and utilization of pressure pumps remained low. As a result, Superior Energy divested rigs in the field.
Despite a relatively steady crude oil price, SPN’s Onshore Completion and Workover Services segment revenue continues to underperform. After a 20% revenue drop in Q1 2019 compared to the previous quarter, it declined by a further 20% in Q2. During Q2, it divested the drilling rigs service line, which means 12 onshore rigs went off Superior Energy’s books. This also means a loss of $33 million of revenues by 1H 2019’s performance. The segment operating loss also declined in Q2 quarter-over-quarter.
SPN would continue to struggle in this segment in the short-term. With only six pressure pumping fleets working, the company’s performance may slip further because the pressure pumping demand has waned significantly, fluid management activity has declined, and further rig divestiture is a possibility. So, the segment revenues may decrease by 15% in Q3, while the EBITDA margin may fall by 15% to 25% compared to Q2.
In comparison, SPN’s Drilling Products and Services segment remained steady in Q2. Year-over-year, the segment revenue increased by 7% in Q2 due to improved premium drill pipe rental revenues. In Q3, the company expects revenues and EBITDA to remain flat or may improve up to 5% compared to Q2.
The most remarkable improvement among SPN’s segments came in the Technical Solutions segment, which saw a 20% sequential revenue growth. The increase was driven by higher completion tools activity in the U.S. offshore market. As a result, the segment operating income recovered tremendously (from $0.1 million in Q1 to $8.5 million in Q2). However, the company is not overly optimistic about the segment outlook in the short-term. In Q3, it expects revenues and margins to remain flat because lower well control and subsea intervention activity can offset the current tailwinds.
The choice of the upstream energy customers has evolved over the years given the excess supply of frac and related equipment and the resulting pressure on prices. The softness in the hydraulic fracking market led to SPN’s decision to reduce the number of frac fleets by 33% to six in Q2. The reduction in the fleet count is expected to bring better economics as the customers can operate at or above the cash breakeven. Over the years, the company has shifted away from being pressure pumping service providers to other areas, including technical solutions services. In Q2, EBITDA from pressure pumping accounted for only 5% of the company’s adjusted EBITDA during the quarter.
The other aspect of the company’s business swing in the U.S. was in the Permian. Permian’s contribution to SPN’s revenue declined to 23% in Q2 2019 compared to 34% in Q3 2018. Of late, the falling margin from the Permian business was one of the primary reasons for the company’s lackluster performance in the U.S. onshore. The company’s management is more optimistic of the offshore recovery to lead to free cash flow generation than any imminent retrieval of the U.S. onshore.
SPN’s completion tool business in the offshore market received more prominence in Q2 after many upstream projects shifted from Q1 to Q2. In the medium-to-long-term, we can expect higher completions activity in the Gulf of Mexico and order backlog to result in higher revenues in the company’s Technical Solutions segment. Since 2010, the company has been investing in product development in sand control completions, a technologically challenging activity. The breakthrough for the company came in 2017 when it received a multi-zone single trip tool technology contract from Hess. Since then, it received several similar orders. The company can now generate profit out of this business, with returns consistently hovering at mid-20% range. It has recently invested in adding to machining capacity that is expected to improve returns. Over a more extended period, the company’s competitiveness in the international market will also improve.
The company’s management thinks that the U.S. onshore market is relatively saturated and the scope of an activity increase there is limited in the short-term. Also, in the service lines which see intense competition, there can be a limited scope of increasing utilization. SPN’s workover and service rigs are operating at 60% to 70% utilization level, which can be considered quite low. Going forward, we may see a healthy mix of completions and production rigs. The other business where the company is facing a lack of demand is in coil tubing. In particular, utilization of the coil tube has been low in the mid-continent in 2019. Also, as competition intensified, the company faced pricing headwinds in some regions, which reduced the margin. The rig utilization and demand for coil tubing are unlikely to improve in Q3. In this scenario, the primary focus for the company is to improve operational efficiency, control costs, and rationalize assets to strengthen or maintain returns.
Over the medium-to-long-term, the company expects activity levels to increase in the U.S. and international markets. Higher E&P can lead to higher revenue share of the higher-margin products, which will improve the company’s cash generation, accelerate debt repayment, and improve the capital structure.
SPN’s management is optimistic about an international activity turnaround. In the international business, the company expects revenues to remain flat in Q3 compared to Q2. However, the current trend of increasing tendering activity in the global offshore market indicates further activity increases in the next several years. For the next several quarters, it expects higher demand for its premium drill pipe in various international regions. Also, in 2H 2019, it plans to start the cementing business in Kuwait, while the company expects additional opportunities to arise in the Middle East over the year.
In 1H 2019, SPN’s cash flow from operations (or CFO) was ~$69 million, which was a sharp improvement compared to a year ago. Despite an 11% decline in revenues, the CFO increased via an improvement in the company’s working capital, primarily due to lower accounts receivable.
In 1H 2019, the company spent $79 million in capex. So, its free cash flow was negative in the first half of 2019 (as capex exceeded the CFO). The company aims to generate $20 million to $30 million of free cash flow in 2H 2019, which can improve the capital structure (by reducing debt). With that objective, it plans to reduce its capex by 28% in FY2019 compared to FY2018.
SPN’s liquidity was $395 million (borrowings available from the revolving credit facility plus cash & equivalents) as of June 30, 2019. Leaving out any refinancing option, it will have $1.1 billion of long-term debt due for repayment in the next one to three years, and further $500 million in 2024. Although there is no potential near-term financial risk, the company will need to improve its free cash flows significantly to avoid default on debt repayment in the medium-to-long term. That is why; its capex reduction program is a significant step towards generating FCF. However, even with positive FCF, it is unlikely to avoid further stress on its balance sheet, given the significant debt load.
SPN’s debt-to-equity ratio (7.1x) is significantly higher than its peers’ average of ~2.0x. McDermott International (MDR) and Oceaneering International (OII) have lower leverage (0.52x and 2.9x, respectively). Dril-Quip, Inc. (DRQ) has not debt.
Superior Energy Services is currently trading at an EV-to-adjusted EBITDA multiple of 3.8x. The forward EV/EBITDA multiple is 4.4x. Between FY2013 and FY2018, its average EV/EBITDA multiple was 19.4x. So, the stock is currently trading at a discount to its past six-year average.
Superior Energy Services’ forward EV-to-EBITDA multiple expansion is in stark contrast to the industry peers’ average multiple compression, which is due to the sell-side analysts’ expectation of a decline in the EBITDA as opposed to the rise in EBITDA for peers in the next four quarters. This would typically result in a significantly lower EV/EBITDA multiple compared to the peers. The stock’s EV/EBITDA multiple is lower than its peers’ (OII, DRQ, and MDR) average of 9.7x. I have used estimates provided by Thomson Reuter in this analysis.
According to data provided by Seeking Alpha, six sell-side analysts rated SPN a “buy” in July (includes “outperform”), while 15 recommended a “hold”. Three of the sell-side analysts rated it a “sell” or “underperform”. The consensus target price is $2.50, which at the current price yields ~213% returns.
According to Seeking Alpha’s Quant Rating, the stock receives a “Very Bearish” rating. Its rating is high-to-moderate on value and growth, while they are poor on EPS revisions, profitability and momentum. I think Seeking Alpha’s assertion of a very low rating on profitability is conservative. Although it is recording losses at the net income level, EBITDA has been positive for many quarters in the past. Also, compared to some of its peers, the profitability rate has not been lower. I agree with the low rating on EPS revision because its earnings missed analysts’ estimates thrice out of the past four quarters. I think its relative valuation multiples are reasonably placed, as I discussed earlier in the article, and so, the high rating on value is justified.
Drubbed by pricing pressure and lower utilization of the pressure pumping assets in North America, Superior Energy has reduced frac fleets and divested the drilling rigs service line in Q2. The Onshore Completion and Workover Services segment has been the most severely affected in the past two quarters. To boost sales and margin, it has been concentrating on improving its international operations. In 2H 2019, revenues from the Middle East, led by a cementing unit contract in Kuwait will push revenues. It has been investing in product development in sand control completions which typically enjoys higher margin but is complex to build. Also, a resurgent offshore market can improve the company’s outlook in North America.
In the medium-to-long term, SPN’s leveraged balance sheet and a low cash flow level can increase its financial risks considerably, unless it manages to refinance the debt, increase cash flows sharply, and divest the non-core assets. Until then, I will not recommend buying the stock because the risks may be too high at the current state.
Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.
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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.