RES Has Not Moved Past The Downside
RPC Inc. (RES) provides specialized oilfield services and equipment primarily to E&P producers in the U.S. and international markets. I do not think the stock will turn around in the short to medium term. As the pressure pumping fleets are stacked across the industry, I expect the equilibrium to be reached in 2020. At that point, the stock price will start moving upward.
The company has decided to cut down on the pressure pumping fleet count in Q4. The Thru Tubing and coiled tubing businesses also are going through a slide, although I think it will be able to hold on to the margin in 2020. In view of the weaknesses cropping up in the industry, the company suspended the quarterly dividend payment. RES’s zero-free balance sheet can lead to an improvement in the relative valuation multiples if the crude oil price weakens and the energy sector’s heads into another crisis.
Industry Indicators: Some Are Up, Some Are Down
In the key U.S. unconventional energy resources, the growth in the DUC (drilled but uncompleted) wells (6% up) and completed wells (10% up) contrasted the drilled wells decline (17% down) in the past year until September 2019. The rise in the DUCs paves the way for a recovery in the completions activities in the medium term, but the fall in drilled wells speaks of the current weakness in the industry.
Within the key U.S. energy shales, RES depends heavily on the Permian region. The crude oil production in the Permian has increased by 19% in the past year, although the rig count here decreased by 14%. Following the pressure pumping asset retirement, it would stop to have a presence in the Bakken. On average, crude oil production in the key unconventional shales increased by 9% in the past year.
Given the improvement in completion techniques, the introduction of technologies like multi-pad drilling and deployment of new equipment, drilling efficiency in the unconventional shales has increased significantly over the past years. As a result, the requirements for pressure pumping services have decreased. During Q3, the company decided to retire older pressure pumping equipment due to a steep fall in utilization and profitability. The decision also helped reduce headcount and improve margin.
In Q3, the company recorded $71.7 million impairment charges related to the retirement of the pressure pumping assets. In this context, investors may note that even the largest oilfield service companies are not spared of the pressure pumping business weaknesses. Schlumberger (SLB) recorded a $1.57 billion impairment charge in Q3 related to the pressure pumping business in North America.
What’s The Outlook?
EIA’s most recent energy price forecast is not bullish for the rest of 2019 and 2020. Consequently, the weakness in pressure pumping and coiled tubing may continue for some time. Investors should be wary of the fact the pressure pumping industry continues to be oversupplied despite the fleet idling of many service companies. Lower pricing and subsequently lower returns have forced RES to consider reducing the pressure pumping fleet drastically. In the coming quarter, it may lower the fleet count to nine from 16, although the more optimistic view would limit the count to 10 to 11. Among those nine pressure pumping fleets, seven would be horizontal fleets, and two are vertical fleets. While most of the horizontal fleets would generate $10 million EBITDA per fleet, the vertical fleets would produce fewer revenues. The company strives to generate at least $10 million EBITDA per fleet for all the fleets in Q4 and the coming quarters.
With a lower fleet count, the company will focus on more highly capable equipment. Plus, with fewer crews, it will have less white space (meaning less downtime), which will allow for more disciplined bidding. It's expected that with the overall restraint in new asset deployment and retirement of older fleets, supply will start to match demand, and the balance in pricing will be restored in 2020. Although demand for pressure pumping services decreased, the company’s fleet utilization did not drop in Q3. So, with increasing efficiency, the company expects the margin to improve in 2020.
The Thru Tubing and coiled tubing businesses, which fared poorly in Q3, are expected to recover modestly in Q4 2019. The company has been investing in coiled tubing units in the past few quarters. But in Q3, it rationalized the fleets to retire some of the older fleets. With more efficient capability, I think the margin will start showing improvement in Q4, although revenues from the business will fall.
Overall, with lower drilling and completions activity and pricing pressure, I think the company’s top-line will fall in Q4. Because more coiled tubing units and Thru Tubing Solutions from competitors are expected to add to the market supply, I think the company can lose market share, which will reduce revenues from the non-pressure pumping sources.
The Current Drivers In The Technical Services Segment
Revenues in the Technical Services, which offers well control, coiled tubing, pressure pumping to downhole tools, snubbing, wireline, and fishing equipment, decreased by 19% in Q3 2019 compared to Q2 2019. As I was discussing earlier in the article, the weakness in the pressure pumping activities led to the revenue loss.
Although the segment operating costs decreased, the decline in pricing was sharper in Q3. As a result, the segment operating income crashed to a $18.2 million loss in Q3 compared to ~$7 million profit a quarter earlier. The Technical Services segment accounted for 94% of the company’s Q3 2019 revenues. Investors also may note that Thru Tubing Solutions (38%) and pressure pumping (37.9%) accounted for the majority of RES’s Q3 sales, followed by coiled tubing (6.7%) and rental tools (4.3%).
Analyzing The Support Services Segment
Quarter-over-quarter, the fall in Support Services segment revenue was relatively less severe (8% down) in Q3. Although operating profit in this segment decreased sequentially, it managed to show some improvement year over year. Though this segment, the company offers inspection and storage services, rental of tubular and related tools, and pipe handling services. Lower rental tools sales prompted much of the decline in revenues in this segment in Q3.
Net Debt Is Negative
The company’s net debt was negative as of Sept. 30 as a result of zero debt, but positive cash and cash equivalents balance ($49.5 million). However, the cash balance has decreased significantly (61% down) in the past year until Sept. 30, 2019.
In FY2020, the company’s capex can fall to $80 million – a 69% decline compared to FY2019. The pressure pumping fleet count fall and the resulting decrease in maintenance capex can lead to the capex fall in the next year. Lower capex can improve the company’s free cash flow in FY2020.
When energy price nose dives, earnings dip, and servicing of debt become difficult, a debt-free company like RES would be better equipped to survive compared to many of its OFS industry peers. However, investors should note that the company has $38.7 million deferred tax liability and $33.6 million liability related to pension and other post-retirement benefits. Precision Drilling Systems’ (PDS) net debt was $1.07 billion as of Sept. 30, 2019, while net debt for National Oilwell Varco (NOV) was $1.17 billion as of that date. Earlier, during Q2, the company suspended the quarterly dividend to strengthen its capital structure and to maintain a conservative balance sheet.
What Does The Relative Valuation Imply?
RPC, Inc. is currently trading at an EV-to-adjusted EBITDA multiple of 5.5x. Based on sell-side analysts’ EBITDA estimates, the forward EV/EBITDA multiple is 7.2x. The current EV/EBITDA multiple is lower than its past two-year average of 11.3x.
RES’s forward EV-to-EBITDA multiple expansion vs. the adjusted trailing 12- month EV/EBITDA is much steeper than peers because the sell-side analysts expect the company’s EBITDA to decline more sharply compared to peers in the next four quarters. This typically results in a much lower current EV/EBITDA multiple compared to peers. The company’s EV/EBITDA multiple is lower than its peers’ (PUMP, NR, and LBRT) average of 8.0x. I have used estimates provided by Seeking Alpha in this analysis.
According to data provided by Seeking Alpha, two sell-side analysts rated RES a “buy” in October (including “outperform”), while 16 of them rated it a “hold.” Eight sell-side analysts rated a “sell” or “underperform.” The consensus target price is $4.95, which at the current price, yields ~9% returns.
According to Seeking Alpha’s Quant Rating, the stock receives a “Very Bearish” rating. Its rating is moderate on profitability, while they are poor on value, growth, momentum, and EPS revisions. I agree with Seeking Alpha’s assertion of a very low rating on growth. However, the very low rating on EPS revision can to too pessimistic. Its earnings missed analysts’ estimates twice out of the past four quarters. I also think its relative valuation multiples are reasonably placed, as I discussed earlier in the article, and so, I would rate the value higher.
What’s The Take On RES?
The rise in the DUC wells typically signals a gradual recovery in the completions activity. The upstream capex decline and the excess supply of the pressure pumping equipment are likely to keep the pressure pumping pricing depressed in the near term. Also, management’s limited visibility beyond 2020 can be a worrying sign.
In this backdrop, RES has decided to cut down the pressure pumping fleet count significantly in Q4. The Thru Tubing and coiled tubing businesses also are going through a slide, although I think it will be able to hold on to the margin in 2020. Because of the weaknesses cropping up in the industry, the company suspended the quarterly dividend payment.
I do not think that RES will be able to turn around in the short to medium term. However, its debt-free balance sheet can help improve valuation if the crude oil price weakens, and the energy sector heads into another crisis. As the pressure pumping fleets are stacked across the industry, I expect the equilibrium to be reached in 2020. At that point, the stock price may start moving upwards.
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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.