PTEN Looks To Improve Shareholder Returns
Patterson-UTI Energy (PTEN) owns and operates onshore drilling rigs and a fleet of pressure pumping equipment in North America. Given the lack of growth in the drilling activity, the company now emphasizes combining a regular dividend payment with an enhanced share repurchase plan. The strategy can protect the stock price from a steep fall. The company's balance sheet is not overly leveraged, which can be useful if the energy market deteriorates. Until growth recovers, the stock will offer limited returns.
PTEN has been adequately swift in understanding and responding to the current energy market uncertainty. It has been lowering its contract drilling rigs and does not expect a quick turnaround. However, the company's pressure pumping business can start to recover because the fracturing services may see an increase in demand in the international market. Operating margin in the pressure pumping segment is likely to hold steady in the short term. It has also revised down the FY2019 capex plans to increase free cash flows, which can be an essential feature if the energy market does not improve soon. Also, it has started to drive down debt and extend the maturity profile.
What Do PTEN's Key Metrics Suggest?
By the end of Q2 2019, PTEN's average rig count was 158, which represented a 10% decline compared to Q1 2019. The company's rig count averaged 150 drilling rigs in July 2019. So, the company has started Q3 with a reduction in the rig count (5% since Q2). Its management was expecting to average 142 rigs in Q3 when it discussed its outlook in the Q2 earnings call. The management also expected 92 rigs operating under term contracts during Q3, and an average of 58 rigs working under term contracts by June 2020. Because the super-spec rigs are typically more productive and earn higher margin, it will get rid of the legacy rigs and field only the APEX rigs after Q3. The management also expects the super-spec rig utilization would remain high in Q3.
How Are The Industry Indicators Doing?
The weakness in drilling activity is led by a decline in the upstream capex budget, driven by the crude oil price volatility. The West Texas Intermediate (or WTI) price, on average, increased by 8.1% from Q1 to Q2. The U.S. rig count, however, was down by 4% because of the lag effect (crude oil price was down by 7% in Q1). Since June, the crude oil price has declined again due to concerns about trade, inventory levels, and global energy demand growth.
The number of drilled wells and drilled-but-uncompleted (or DUC) wells remained nearly unchanged in Q2 compared to Q1 in the key unconventional resource shales. Since June, however, the drilling activity has weakened. What does this mean? It signals the drillers in the unconventional shales have not found the necessary confidence (or adequate margin) to increase completions activity given the current weakness in the crude oil price. Total energy production, however, has not decelerated due to the tremendous improvement in drilling efficiency in the past couple of years. By May 2019, the U.S. total energy production increased by 9.6% in the past year. In comparison, global energy production growth was much lower (2.8%) from 2017 to 2018.
Contract Drilling Segment: Performance And Outlook
In the past year until Q2 2019, PTEN's average revenue per operating day increased by 11%. However, the improvement was more than offset by significantly lower rig count (10% lower). As a result, the company's Contract Drilling segment revenues, which accounted for 54% of the Q2 revenues, remained nearly unchanged year over year. Higher revenues led to higher average rig margin per operating day (23% up) during Q2 compared to a year ago. Operating margin for the segment turned positive in Q2 2019 from an operating loss in Q2 2018.
As of June 30, the company's term contract for drilling rigs, or backlog, was ~$720 million, which was 11% higher compared to its backlog on March 31, 2019. The higher backlog was due to the long-term contract extensions on several rigs and indicates increased revenue visibility in the future. So, the improved backlog can affect the company's top line positively in the short-term. The effect on the margin, however, can be challenging to foresee. In the Q2 2019 earnings call, the management commented that it expects EBITDA margin per day to decline by 4% in Q3 compared to Q2 led by lower revenue per operating day. Lower fixed cost absorption and costs associated with rig stacking can dent the company's operating margin in Q3.
Pressure Pumping Segment: Performance And Outlook
PTEN's Pressure Pumping segment revenues decreased by 41% year over year in Q2 2019. The company's active frac spread declined to 15 in Q2 from 16 in the previous quarter, and 20 from the beginning of the year, reflecting a reduction in completion activity. Deterioration in pressure pumping demand and lower spread resulted in the year-over-year revenue fall in Q2. Quarter over quarter, the company was able to hold its ground, both top line and bottom line. EBITDA per spread increased by 18% from Q1 to Q2.
While the management expects to maintain 15 active spreads in Q3, the mix can shift to more single well pads. With pricing remaining challenging, we may see a 10% reduction in revenues and a 22% lower gross margin in the segment in Q3. The company's spreads are primarily located in the Permian, South Texas, Mid-Continent, and Northeast. While in the recent past, it moved spreads out of the mid-con and between South Texas and West Texas, it does not look to change the geography mix in the short term.
In the company's other business, including the E&P business, rental business, and technology businesses, revenues, and gross margin are expected to remain resilient in Q3 compared to Q2.
How Will The Industry Forces Affect The Company?
Typically, the E&P companies would slow activity in Q4 when they reach the end of their capex budget. But 2019 has been different. The constant focus on capital investment pruning and living within the cash flows have slowed down the spending rate, which will decelerate the Q3 drilling and completion activity more than the typical years. Rig count may stay steady or may drop in Q3. However, beyond that, it's difficult to forecast the Q4 drilling activity, given the current crude oil price volatility. One thing that has been positive so far for PTEN is that the frac spreads are generating positive free cash after capex. Based on lower rig count expectation, the hydraulic fracturing activity, too, may decrease in Q3.
Dividend And Repurchase
PTEN pays $0.04 quarterly dividend per share, which amounts to 1.85% forward dividend yield. In the past five years, its dividend has decreased by 6.9%. Helmerich & Payne's (HP) dividend yield (7.56%) is higher compared to PTEN.
Since July 2018, the company thrice increased its share repurchase program. In 1H 2019, it repurchased $150 million worth of shares. Total shareholder returns (dividend plus repurchase) amounted to $166 million in 1H 2019.
FCF, Capex, And Debt
In 1H 2019 2019, PTEN's cash flow from operations (or CFO) was $365 million, which was an improvement over a year ago. Despite a decrease in revenues, the company's CFO improved on account of lower account receivable. In 1H 2019, it spent $215 million in capex, leaving $150 million as free cash flow (or FCF), which was a significant improvement compared to negative FCF a year ago.
Recently, the company has revised down its FY2019 capex estimates to $400 million from $465 million as disclosed earlier. The revised guidance would be 32% lower than FY2018 due to the reduced spend on rig upgrades. Now that the company is on schedule to upgrade its entire fleet in the U.S. to APEX-grade fleet, there is less need for additional capex. Investors may note that more efficient rigs can deliver drilling at a lower cost, which will keep demand high, even if the crude oil price shows no vast improvement.
PTEN has a relatively low debt-to-equity ratio (0.34x) compared to its peers. Nabors Industries' (NBR) leverage was 1.2x as of June 30 while Helmerich & Payne's leverage was 0.12x. Pioneer Energy Services' (PES) leverage was 3.8x as of that date. PTEN's liquidity (borrowings under a revolver plus cash & equivalents) as of June 30 was $856 million.
In August, PTEN borrowed $150 million that will mature in 2022 and repaid $300 million in debt that would mature in 2020. In effect, it reduced total debt by $150 million and extended the maturity. Now, the company has $450 million due in 2022, and further $525 million after 2023, unless it works out some debt repayment rescheduling. Although dividend and share repurchase exceeded FCF in 1H 2019, with lower capex, we can expect FCF to increase in 2H 2019. Higher FCF, plus strong liquidity, gives the company adequate fund to manage its debt, dividend payment, and share repurchase in the near to medium term. Over the medium to long term, the company might need to improve cash flows to lower leverage while making adequate shareholder returns.
What Does The Relative Valuation Imply?
Patterson-UTI Technology is currently trading at an EV-to-adjusted EBITDA multiple of ~3.8x. Based on sell-side analysts' EBITDA estimates, the forward EV/EBITDA multiple is 4.4x. Between FY2015 and FY2018, the stock's average EV/EBITDA multiple was 9.5x. So, it is currently trading at a steep discount to its past average.
PTEN's forward EV-to-EBITDA multiple expansion versus the adjusted trailing 12-month EV/EBITDA is in steeper compared to the peers because sell-side analysts expect the company's EBITDA to decline more sharply compared to the fall in EBITDA for peers in the next four quarters. This would typically result in a lower EV/EBITDA multiple compared to peers. PTEN's EV/EBITDA multiple is lower than its peers' (NBR, HP, and PES) average of 5.6x. I have used estimates provided by Seeking Alpha in this analysis.
According to data provided by Seeking Alpha, 18 sell-side analysts rated PTEN a "buy" in September (including "outperform"), while ten of the analysts rated it a "hold." None of the analysts rated it a "sell." The consensus target price is $12.6, which at the current price yields ~31% returns.
What's The Take On PTEN?
PTEN is faced with a scenario where the energy market uncertainty is trending into a downturn. There are increasing challenges to the upside, both at the macro level and operationally. In response, it has been lowering the contract drilling rigs and does not expect a quick turnaround. However, the company's pressure pumping business can start to recover because the fracturing services may see an increase in demand in the international market. Operating margin in the pressure pumping segment is likely to hold steady in the short term.
Given the lack of growth, the company looks to combine a strategy of steady dividend payment with an enhanced share repurchase plan. Also, it has started to drive down debt and extend the maturity profile. In the short to medium term, the stock will provide limited opportunity to gain on the upside.
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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.